The first serious report on the May 6 ‘Flash Crash’ on Wall Street hasn’t produced a ‘smoking gun’ as many investors hope, instead it has listed what is thought didn’t happen, and a list of factors that probably helped create the brief crash.
But no fat fingers, no cyber terrorism, or attempts to corner the market caused the sharp slump.
And until the regulators know for certain what caused it, it could happen again in the future when there’s a sharp rise in financial strain in the markets.
And that’s a big worry given the way fear has returned to dominate investor sentiment around the globe. Wall Street is now seen as a potential weak point, rather than a strength.
But more worrying the ‘Flash Crash" on Wall Street seems to have happened because there are too many markets run by too many people/companies, many of whom had no interest in maintaining market liquidity while share prices plunged.
Instead, the findings of a joint report from America’s two senior market regulators reveals that many of these 50 markets actually rely on the older New York Stock Exchange and Nasdaq to provide the buying liquidity when there’s none on the newer electronic markets.
The report from the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) blames a combination of a "liquidity mismatch" between linked exchanges, stop loss orders and market orders (a way of buying that big computer driven traders use).
The report said "We have found no evidence that these events were triggered by ‘fat finger’ errors, computer hacking or terrorist activity, although we cannot completely rule out these possibilities”.
The Dow fell 9.2%, or 998.50 points, in a matter of minutes from 2.40 pm on May 6.
The market then rebounded, but still finished sharply lower on the day.
Regulators and the various exchanges have been investigating since and still haven’t actually pinpointed the precise cause.
But the joint report released this week, does rule a number of theories out and hardens up the suggestion that it was a shortage of liquidity in many newer markets.
One theory being investigated sounds the most relevant: “In the U.S. securities market structure, many different trading venues, including multiple exchanges, alternative trading systems and broker-dealers all trade the same stocks simultaneously,” the report said.
“Disparate practices potentially could have hampered linkages among some of these trading venues and led to fragmented trading.”
The report says the investigation is looking at a number of possible factors, including "a generalized severe mismatch in liquidity, as evinced by sharply lower trading prices and possibly exacerbated by the withdrawal of liquidity by electronic market makers and the use of market orders, including automated stop-loss market orders designed to protect gains in recent market advances".
In other words, many of the new markets and the companies running the automated trading systems had no interest in providing continuing liquidity, instead they protected their profits and let the market and many shares sink, some to a cent.
As a result, the SEC proposed rules to halt trading in individual stocks that swing more than 10% over 5 minutes.
"We continue to believe that the market disruption of May 6 was exacerbated by disparate trading rules and conventions across the exchanges," said SEC Chairman Mary Schapiro.
"As such, I believe it is important that all the exchanges quickly reached consensus on a set of uniform circuit breakers that would be triggered when needed."
The SEC said the pause would "allow the markets the opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion. Initially, these new rules would be in effect on a pilot basis through December 10, 2010."
While the study stops short of assessing blame in the sell-off, its findings support a conclusion that conflicting rules on as many as 50 U.S. market centres helped fuel a chain reaction of selling that sent equities tumbling.
