Senators fear a repeat of 'flash crash' market plunge

McClatchy NewspapersMay 20, 2010 

WASHINGTON — With the cause of the May 6 stock market "flash crash" still unclear, senators told top federal regulators Thursday to take more aggressive steps to ensure that the unnerving market plunge doesn't happen again.

Members of the Senate Banking Committee's Securities, Insurance and Investment Subcommittee seemed most troubled that regulators couldn't rule out a repeat of the nearly 1,000-drop on the Dow Jones Industrial Average despite their promise to require new "circuit breakers" in June to slow trading across all U.S. exchanges when turbulence hits.

"I'm worried (that) by a lack of not getting something done we could have a repeat," said Sen. Jim Bunning of Kentucky, the subcommittee's top Republican. As he spoke, the Dow was down by more than 300 points, as if to punctuate his point.

What seemed to trouble senators most, however, was a sensation that high finance may prove similar to the surprise oil spill in the Gulf of Mexico: Protections may be insufficient when the unexpected occurs.

"My gut just says we may be looking at the beginning of what could be the next crisis," said Sen. Mark Warner of Virginia, who's become the most prominent pro-business voice among Senate Democrats.

Securities and Exchange Commission Chairman Mary Schapiro said she shared Bunning's "sense of urgency," but that the existing brakes on market trading would have to do for now.

That didn't sit well with Bunning.

"I think there comes a time when you take emergency action," he said. "All you have to do is come here and ask, because we don't want a reoccurrence and we sure don't want to arbitrarily break (stock) trades. I would urge you to come and directly ask this committee for emergency powers."

Questioning regulators, Warner, a pioneer entrepreneur in the cellular phone industry, wondered aloud whether computer-driven trading benefits society. Wall Street firms use software-deployed algorithms to trade massive volumes of stocks and other financial instruments in fractions of a second. That's thought to be a primary contributing factor to the May 6 market plunge.

"Did we see on May 6 the first warning shot of what could be the next systemic crisis because of technology run amok?" he asked, later suggesting that gains from massive computer trades come at the expense of ordinary investors. The people behind these trades "are making hundreds of millions in investments to get an advantage (and) are not doing it simply just to add liquidity to the marketplace. They're not doing it as a sign of corporate good will."

Schapiro responded that she's taken numerous steps to bring greater transparency and oversight to Wall Street, and she's overseeing a rethink of regulation to protect ordinary investors. She was sympathetic to Warner's view that financial markets are supposed to be about providing capital so that companies and corporations can expand.

"At the end of the day, our markets have to be about investors and how companies raise capital," Schapiro said.

The senators also were upset that some stock exchanges canceled, after the fact, some transactions that occurred during the May 6 drop. Schapiro, who's called on the exchanges to develop a unified method for canceling trades, said the exchanges make that call, but she acknowledged that the May 6 cancellations appeared "arbitrary."

Testifying alongside her, the chairman of the Commodity Futures Trading Commission, Gary Gensler, gave new information about what regulators think happened on May 6.

They've said that a confluence of events, not a single action, most likely caused the sharp drop. These "events" included growing uncertainty that day about problems in Europe, volatility in currency and bond markets, and the main U.S. exchanges being down more than 2 percent in midday trading before the rout began around 2:40 p.m.

The skid appears to have begun in what's called an exchange-traded fund, a security that tracks a stock or futures index. The price of the fund moves throughout the day. The particular exchange-traded fund in question was the mini S&P 500, which tracked bets in the futures market about what might happen on the S&P 500.

Gensler said that on May 6, sell orders were far outstripping buy orders. As this happened, he said, some big players simply pulled out of this market. One player accounted for 9 percent of the orders.

Additionally, he said, many traders use software that has a pull-down menu, similar to a software program on a personal computer, that allows them automatically to limit their market participation by a percentage of their choosing. This perhaps added to a cumulative pullback.

Under normal circumstances, sell orders for the mini S&P would have taken hours to clear, but on May 6, 10 times the usual volume of trades were placed over a 21-minute period, Gensler said.

He pledged a closer look at computerized trading. Part of the problem could turn out to be not so much the use of algorithm-based trading, but a lack of mechanisms to recalibrate.

"Just because it's an algorithm, don't think smart," he cautioned.

Gensler and Schapiro have said a cyber-attack by hackers seems an unlikely explanation for the May 6 volatility.

ON THE WEB

Schapiro's testimony

Gensler's testimony

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