The US market authorities and the various exchanges still can’t tell the world just what caused the Great Crash of 2.45pm on Thursday May 6 (aka the Flash Crash).

The Securities and Exchange Commission hauled the heads of several exchanges to Washington overnight to discuss what happened and compare notes. There was agreement to make several changes to head off a repeat, but we weren’t told what these changes will be.

So was it “Fat Finger”, a computer glitch or perhaps something deeper, say an act of cyber terrorism or an attempt to short the market or do you fancy the confluence of technology and mankind, where the machines are too fast (and the software too accurate) for their human controllers?

All of these and none? Five days after the crash, those who should know, can’t or won’t say. Can’t is more like it.

The regulators and various exchanges, and the operators of these high-speed trading networks, have a lot of suspicion and several theories, but no one can say exactly what caused the market to plunge 998.50 points in minutes, wiping about $US1 trillion off its value of the market.

As a result of the plunge and bounce, Nasdaq, one of the major US exchanges, has said it will cancel trades in 296 shares, including giants such as Proctor and Gamble and a host of tiddlers.

And the plunge caused concerns right to the top of the government: it has been reported that during the plunge, Timothy Geithner, the US Treasury Secretary, held a conference call with Fed chairman Ben Bernanke, as well as regulators from the SEC and the Commodities Futures Trading Commission. No one knew, it must have been quite scary.

Tonight, a US House of Representatives committee will hold a hearing to investigate the causes of the drop, which would have been the Dow’s biggest one-day fall without the late rally.

US share markets have been spinning the blame away from themselves: The New York Stock Exchange “confirmed” even before the market had closed on Thursday that there had been no system errors on its part and Bloomberg quoted Larry Leibowitz, the chief operating officer of NYSE Euronext, as later blaming computer trading for the plunge, saying that an orderly sell-off had snowballed because of orders sent to venues with no investors willing to match them. Nasdaq stressed that its systems had all performed as normal during the plunge.

And the CME Group, owner of the Chicago Mercantile Exchange where futures are traded on several indices (including the most important, the S&P 500 contract), said its markets were “functioning properly” at that time.

The CME also seems to have killed off a rumour on Wall Street and in London that a typing error by a trader at Citigroup (the fat finger f-ck-up) sparked the sell. That was reported to be the huge a sale of 16 billion e-mini S&P contracts rather than 16 million. The CME said that it confirmed “that activity by Citigroup Global Markets Inc in CME Group stock index futures markets did not appear to be irregular or unusual”.

When these circuit breakers slowed trading on the New York exchange as indices hit certain levels on the way down, computerised trading at brokerages may have diverted “sell” orders to smaller exchanges in the US. These exchanges don’t have the market depth or liquidity to handle a surge in volume, especially selling. So with little liquidity or circuit-breaking, the computer-driven “sell” orders may have triggered further computerised selling, which in turn could have fed on itself: a perfect negative feedback loop.

With the New York Stock Exchange out of the loop, these other, newer electronic exchanges had no depth or liquidity, so shares fell into this black hole. This seems to have been accentuated by the nature of the new auto trading programs that are built around exploiting small price differences of one cent or so.

The dumb programs were trying to sell into a market where there were no buy orders. Because they are programmed to look for the best price on the sell side, they continued dropping the price and then headed for zero and reset at 1c in many cases (so this explanation goes.

Without a human involved to try to work out why there were no selling bids in the market, the machines and their programs kept dropping prices, presumably till they either stopped, froze or went into their own black holes and refused to work. This could have been why Dow stopped 998.50 down.

Peter Fray

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Peter Fray
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