Stock market plunge still a mystery
By Kevin G. Hall
McClatchy-Tribune News Service
WASHINGTON — The nation's top financial-market regulators yesterday all but ruled out the possibility that cyber-terrorism, computer hackers or a so-called fat finger trade were behind last week's sudden, unprecedented drop of the Dow Jones Industrial Average by nearly 1,000 points.
"At this time, we have not identified any information consistent with computer hacker or terrorist activity," Mary Schapiro, the chairman of the Securities and Exchange Commission, said in prepared remarks for a subcommittee of the House of Representatives.
Addressing a House Financial Services subcommittee, Schapiro also discounted news reports that a trader mistakenly entered an order for billions of shares when he meant to key in millions.
"While we cannot definitively rule that possibility out, neither our review nor reviews by the relevant exchanges and market participants have uncovered such an error," she said of a trade dubbed a "fat finger" mistake.
Regulators are trying to identify the trigger on a day in which 66 million trades were executed — 17 million between 2 and 3 p.m., when the plunge and rebound occurred. Schapiro promised preliminary staff findings next week.
"In order to have stability in the market, we shouldn't withhold anything from the public," Rep. Paul Kanjorski, D-Pa., told Schapiro, warning that a delay could allow conspiracy theories to take hold.
He also asked whether last week's plunge could repeat.
Schapiro responded: "I have to say not impossible."
Schapiro ruled out the market forces of supply and demand as the cause.
"Clearly something didn't work unrelated to market forces that we normally applaud ... and (which) make our markets better," the SEC chairman said.
The SEC and the Commodity Futures Trading Commission have met with the heads of stock and commodity exchanges in an effort to understand what triggered last week's plunge and equally fast partial rebound.
Late Monday the two agencies announced tentative agreement with the heads of exchanges to expand the use of "circuit breakers" that would kick in to slow or halt trading in unison across all markets and in individual stocks and financial instruments when there are unusual steep drops in trading like the one that triggered global panic last Thursday.
Schapiro said some broad "circuit breakers" would be announced this week, but that it would take longer to determine some technical measures, such as what percentage change in a stock's price would trigger a temporary break.
In his testimony, CFTC Chairman Gary Gensler noted that much attention now focuses on the lightly regulated derivatives market.
Gensler said there was a chance that events in unregulated over-the-counter markets triggered problems or amplified them. These dark markets would be regulated under a sweeping revamp of financial regulation that's now before Congress.
Without identifying a specific trigger to the chaos, Gensler and Schapiro said that problems in debt markets — rooted in concern about European defaults — weighed heavily in the background. Currency markets were volatile last week because of worries that Greek debt problems could spread to larger economies, such as Spain and Portugal, and undermine the euro.
Gensler explained that "markets do work on greed and fear," and that four factors contributed to fears last Thursday: global debt worries, market signals that encouraged sales, some large players exiting trading activity because of volatility, and hedging activities as prices fell.
Last week's chaos also spotlighted a controversial practice called high-frequency trading. That involves an automated computerized trading platform — deployed by hedge funds and large investment banks such as Goldman Sachs — that executes a huge number of orders at very high speeds.
Such "flash trading" is thought to have turned a downturn into a near-collapse last week. That's why regulators now are looking at harmonizing "circuit breakers" across numerous exchanges to prevent another thousand-point drop.
Lawmakers expressed concern yesterday that these traders can execute millions of orders in multiple markets within seconds. They rely on software involving complex algorithms to detect market trends in fractions of a second and then trade on them.
"I think the question before us is: What is the utility of high-frequency trading?" said Rep. Brad Sherman, D-Calif. He suggested that this sort of trading by hedge funds and big Wall Street investment firms is "parasitic attachment" that takes profit that would've gone to ordinary investment.
Sherman suggested a "small tax, to recognize that there is a social cost to this activity." The chairman of the full committee, Rep. Barney Frank, D-Mass., said that perhaps small investors needed to be compensated for losses last week because of the problems brought by massive computerized trading.