Flash Crash

Fast mega-expensive computers, programmed by some of the most highly-educated (expensive) specialists, linked very directly and electronically to the relevant commodities and stock exchanges give the Wall Street traders that own them a huge advantage over everyone else. These computer systems can spot trends – strengths and weaknesses across the board, in specific sectors or individual stocks and commodities – in tiny fractions of a second and automatically initiate buy or sell orders just as fast (flash trading). But since there are quite a few such systems operating – you may assume every major financial player on the Street has and uses these systems – they also react to each other. After when one computer detects a triggering price change and initiates an order based on that information, all the other computer systems detect that transaction – usually a large order – instantly… and themselves react. The losers are those who are left with the spoils of the market after such an automated frenzy has decimated or seemingly irrationally exploded the market.

The second big casualty of such practices is the falling confidence in the market structure itself, and in a recession where there rarest commodity appears to be confidence at every level, these practices only undermine the possibility of restarting our economy. The market rises 500 points, falls 300 points, another 150 points, rises 200 points, all in a relatively short time span. Such big and sudden drops, precipitated by automated trading, are called “flash crashes.” Who would believe in a market with such volatility? Certainly not the vast majority of Americans who don’t have supercomputers in their basements applying sophisticated software to implement trading decisions. There are a few slogan-driven constituencies who somehow believe that there is a free market and that regulation is hardly necessary, but then these folks don’t read my blog… or anything that contains documented facts versus unsubstantiated and mistaken assumptions.

“‘There is something unholy about them,’ said Guy P. Wyser-Pratte, a prominent longtime Wall Street trader and investor. ‘That is what caused this tremendous volatility. They make a fortune whereas the public gets so whipsawed by this trading.’” New York Times, October 8^th. It’s not just that this power elite has a technological advantage that only vast wealth can buy, but it also has a mechanism to manipulate the market itself, a fact that may be illegal but most difficult to enforce.

“Layering” is one such manipulation, in which the trader issues a large order (that they never intend to carry out) and then cancels. The market reacts to the order, and the trader takes advantage of the market move they created without implementing. Occasionally, these fakes are discovered and fined, but often they emerge without any sanctions. A secondary impact is when the computer issues an order for thousands of transactions that is countermanded by man or computer, one that really was intended but cancelled for any number of reasons. The results are the same.

The reality is that market-trading has changed without a concomitant change in how the markets are regulated. “High-frequency trading took off in the middle of the last decade when regulatory reforms encouraged exchanges to switch from floor-based trading to electronic. As computers took over, daily turnover of stocks rose to 8 billion shares in the United States from about 6 billion in 2007, according to BATS Global Markets… The trading, done by independent firms or on special desks inside big Wall Street banks, now accounts for two of every three stock market trades in America… Such trading has expanded into other markets, including futures markets in the United States. It has also spread to stock markets around the world where for-profit exchanges are taking steps to attract their business…

“Global regulators are considering penalizing traders if they issue but then cancel a high degree of orders, or even making them keep open their orders for a minimum time before they can cancel. Long-term investors worry that some traders may be using their superior technology to detect when others are buying and selling and rush in ahead of them to take advantage of price moves. This is driving some investors who buy and sell in large blocks to move to new so-called dark pools — venues away from public exchanges. As more trading takes place in these venues, prices on exchanges have less meaning, critics say.

“In the United States, the Securities and Exchange Commission has been looking into the new market structure for almost two years. In July, it approved a “large trader” rule, requiring firms that do a lot of business, including high-speed traders, to offer more information about their activities in case regulators need to trace their trades… After the flash crash [on May 6, 2011], exchanges introduced circuit breakers to halt trading after violent moves. Bart Chilton, a commissioner at the Commodity Futures Trading Commission, called for regulators to go further. He wants compulsory registration of high-frequency firms and pre-trade testing of their algorithms.” NY Times.

The Dodd-Frank bill was supposed to empower the Securities and Exchange Commission to impose new regulations in this Wild West, cowboy-driven market sector, but budget cuts and resultant staff reductions have produced only about 10% of the regulations that even this watered-down legislation was supposed to create. Meanwhile, Wall Street is engorged in the excess of their own creation, reveling in the almost complete lack of oversight, and enjoying the power of being able to contribute unlimited sums to political action committees without restraint. Yes, American, any notion that deregulation is good for America seems to fly in the face of… FACTS.

I’m Peter Dekom, and if you think our nation is polarized right now, let the power elite continue to have its way and we will have distant memories of what was once the American middle class.