The flash crash in May 6th saw 10% of the value of the Dow Jones index disappear in a few minutes :-
I read an article on this on the BBC this morning, following the publication of the SEC investigation into the event. The headline shouted that they had missed the point by saying “US May shares crash caused by a single trader”. The reason I say that it fundamentally missed the point is that in a market of thousands of traders, mistakes and misunderstandings are not just possible, they are guaranteed. This kind of event is fundamentally unlikely to be caused by any one trader, it is caused by the market structures not being robustly designed. That it should go ‘out of control’ spectacularly is wholly unsurprising if it does not have the right damping and controls to prevent it. The trader is simply the trigger, not much more culpable than the ‘butterfly in China that causes the hurricane in the US’ (read ‘The black swan’ by Nassim Taleb , or my review of it here, for more information about why this is true).
So, the BBC headline having piqued my interest, I read the article to see if it at least had more balance in the body. It didn’t. There was nothing to indicate to a reader who did not understand markets that the issue was the market, not the trader. So, I wondered if the issue was the SEC report itself. It isn’t. It has two very clear early sections ‘what happened’ and ‘lessons learnt’. The first talks about the forensic analysis of the sequence of events, including triggers. It notes that this event started with a very large trade, executed with no price caps, in a very short period of time … not the smartest of moves by the trader, but allowed by the rules, and not prevented by any controls in the system. The ‘lessons learnt’ section talks exclusively about the specific failures in the way that the market operated … and notably, made absolutely no mention of the trader, recognising clearly that the failure was not there. There is no talk of criminal activity, or market abuse, as you would expect if the trader was the real cause.
From my perspective, it does not really stand back enough, since it talks about some specific changes such as ‘circuit breakers’, but does not look at the dynamics of the system. From a control theory perspective (my specialism at university, so a lens I use a fair bit) you need some damping in this system, not just chances for use of tacit knowledge and hopes of more stable deep liquidity. Damping, for example (I suspect) a tax on transactions, will stop wild swings. Short outages will prevent small stuff, but when you get to the end of the time or liquidity, if the situation is not resolved you WILL explode. Outages also risk turning into unexpected real time delays, and they are very dangerous for stability of any system.
But, returning to the report, what is notable is that the lessons learnt section is pretty technical. It is obvious how much more ‘interesting’ it would be any news story, such as the BBC’s, was based on the narrative about a single rogue trader or firm than arcane technicalities. And, it is defensible to the extent that there are no untruths in the article. But all the important truths are left out. You can’t even call it a fiction ‘based on real events’ since the important events don’t get a mention. This is what I would expect from the Daily Mail, though in fact I find nothing there at all … which makes them in this case more accurate than the BBC, which I never thought I’d find myself saying (though I know in my heart it just that they probably correctly thought it was too boring for their readership).
I thought it was worth a quick trawl elsewhere to see if the BBC was an outlier, and also to tune up what I consider helpful sources of news vs. junk. The Wall Street Journal does somewhat better, since it notes the single trade as a catalyst, and says “It didn’t answer a key question: If one trade could cause so much turmoil, why hadn’t that happened before?” This is still not quite there, since it implies that this can’t be the issue since it hasn’t happened before, rather than noting that pushing a system to be very stable when stable, often makes it massively unstable when stressed. The New York Times article is very similar. CNN does a little better, though it still allows the original trade to dominate the text.
But, the Washington Post finally gets there, noting “The report by the Securities and Exchange Commission and the Commodity Futures Trading Commission made clear that the nation’s financial markets were far more vulnerable on May 6 than was previously known and that regulators had failed to keep up with the rapidly increasing size and complexity of markets.” And, the Economist does get this pretty much spot on, even though it starts with the unpromising headline of ‘One big bad trade’. This is already my favourite paper, and this check has burnished its reputation with me.
Finally, it is worth noting that there is already an updated article in Wikipedia, which also covers this well by having a long section on the circuit breakers. How different is the world today than the Encyclopedia Britannica, where I can KNOW that the article on this topic will be updated pretty much the instant that new information is known.
But, the BBC article feels very poor.