Tuesday, August 24, 2010

End Speculation, Before It Ends You

Today is Tuesday, 24 August 2010.

Recall the Great Flash Crash of 6 May 2010? In little over 15 minutes, the Dow dropped 998.5 points, some 9%, erasing some $1 trillion in market value. Then, in a totally unprecedented occurrence, it largely rebounded, closing down 447.80. All on no news which could have triggered such a decline. (Sure, some nervous Neds were jittery over the European debt crisis, but that wasn’t a sufficient explanation.)

You should read the article cited below in yesterday’s The New York Times. A data analysis firm in Chicago has discovered some interesting patterns in the trading on that day. The SEC and the Commodities Futures Trading Commission are expected to issue a report next month.

Almost certainly, high-speed computer trading played the central role. Hot shot analysts develop multiple trading strategies, which are then deployed by dozens of firms, resulting in millions of trades at the speed of light. Problems can occur, of course, when competing programs interact in the markets, producing conditions unforeseen by the analysts, while the programs automatically keep spitting out trades as if nothing out of the ordinary were happening, and prices on the various stock exchanges go insane.

On 6 May, this led the Infallible Invisible Hand of the Imaginary Friend of the Market to value stocks such as Accenture, CenterPoint Energy, and Exelon at one penny per share, while valuing stocks such as Sotheby’s, Apple, and Hewlett-Packard at more than $100,000 per share, valuations clearly at odds with reality.

Enter our old friend, the Efficient-Market Hypothesis (EMH), which holds that free markets, by their very nature, incorporate all relevant information, and set proper prices. Such as $.01 per share for Accenture, which had a market capitalization of more than $28 billion the moment before the Great Flash Crash began. Snicker!

A central problem is that stock markets are not meant solely as a means “transparently” to determine rational prices for stocks; they also serve as a mechanism for speculation in search of quick profits, regardless of the underlying values of companies.

Essentially, high-speed computer trading is day trading by firms deploying hundreds of billions of dollars in speculation, causing small-to-huge swings in stock prices, which are partially-to-entirely decoupled from underlying values. This is a recipe for disaster, as the Great Flash Crash seems to have demonstrated.

The only rational response is that irresponsible speculation must be highly regulated, and, in many cases, outlawed. Crazed free-market idolater-ideologues will of course respond, “Socialistic sacrilege!”, “Tool of Satan”, etc.

The question is: should society facilitate making a quick buck, at the risk of fundamentally injuring entire national economies and devastating millions of small investors? Your answer depends on whether you worship mammon or love humanity.



On this date in 79, Mount Vesuvius erupted, burying Pompeii and Herculaneum.

On this date in 1902, the great historian Fernand Braudel was born. Everyone should read Civilization and Capitalism, 15th to 18th Centuries (all three volumes, please).

On this date in 1922, the historian and left activist Howard Zinn was born.


Anonymous rtr said...

Good post today HH. How many ways does it take to discredit laissez-faire capitalism. Taken entirely by itself, this incident demonstrates the necessity for a regulatory hand to slap the invisible (pink unicorn's) hand of the market. Things got so bad so fast that the market had to "go to the timeout room" while traders got a get out of jail free card pause to regroup.

Laissez-faire is an absolute akin to pregnancy. You either is or you ain't. Beyond that, it's just a matter of degree.

Laissez-faire v. regulated markets - you either is or you ain't. It's just a matter of degree.

11:27 PM  

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