Saturday, May 22, 2010

Flash Crash preliminary report

The Commodities Futures Trading Commission (CFTC) and the Securities Exchange Commission (SEC) issued a preliminary report on the flash crash of May 6th. Fundamentally, there is no conclusion in the report. It does however; deduce some suspects for the temporary but serious liquidity shortage.

The report states that Exchange-traded funds (ETFs), individual equities, short selling, and S & P futures were all factors in the flash crash. Also, the report suggested that the NYSE Euronext circuit breaker which kicked in to slow down trading may have accelerated the exodus of trades to other exchanges contributing to the loss of liquidity.

It is extraordinary to think that determining the cause of this crash is so elusive. Why is it that every time we demand answers, Wall Street explains to us how ‘complex’ and complicated what they do is? How can that be?

Stocks are bets that companies will do well and hence prices will go up. Derivatives are bets that something-a company, a commodity, a mortgage, will go up, down (fail) or maybe go sideways. That is not the hard part. The difficult part for the CFTC and SEC must be how quickly these trades can go from exchange to exchange leaving disaster in their wake. And if that is it, why did nobody anticipated this??

Either they really don’t know what happened on May 6th, which is so scary, or they know and need time to present matters in a palatable way given the political climate. (e.g. Financial Reform moving forward)

Taking everything at face value, the report states that it will take time for staffers to go through the voluminous trades and data from that day. Until they can analyse that information no one will know for sure what caused the precipitous drop in prices. Hopefully, pressure will remain on these regulatory agencies until they determine and publish a report explaining the cause. If the problem is technology getting ahead of the exchanges or getting ahead of regulation then some time needs to expended rectifying that shortfall.

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