PALM DESERT, Calif. – Shortly after Nan Noonan, managing director and chief systemic risk officer of The Depository Trust and Clearing Corporation, was warning attendees of the 2010 Securities Industry and Financial Markets Association Operations Conference that Greece was dealing with a systemic problem affecting other countries that could call into question the entire viability of the Euro as a currency, the Dow Jones Industrial Average plunged almost 1,000 points.
The panic-like drop was spurred by concerns about Europe’s ability to bail out Greece– and was spurred on by heavy doses of automated trading that caused many stocks to enter near-freefall conditions.
The big plunge came at approximately 2 p.m. Eastern time, with the Dow’s trough coming at roughly 2:30 p.m. Noonan’s panel on systemic risk at the industry conference on how Wall Street should operate began at the equivalent of 1 p.m. and ended at 2 p.m. Eastern.
The Dow finished down 347.80 points, or 3.2%, at 10520.32.
And the wild swing had political statement written all over it, as Congress continues to move toward financial reform in the Senate and House. Almost immediately, Sen. Ted Kaufman (D-Del.), a harsh critic of Wall Street over the past two years, released a statement saying the "growing sovereign debt and banking crisis in Europe is very troubling. The U.S. needs to get its financial house in order through strong Wall Street reforms that will serve as a lasting bulwark against financial instability.
"I also have been warning for months that our regulators need to better understand high frequency trading, which appears to have played a role today when the U.S. market dropped 481 points in 6 minutes and recovered 502 points just 10 minutes later. The potential for giant high-speed computers to generate false trades and create market chaos reared its head again today. The battle of the algorithms–not understood by nor even remotely transparent to the Securities and Exchange Commission–simply must be carefully reviewed and placed within a meaningful regulatory framework soon."
And, indeed, The Wall Street Journal reported that black boxes – automated trading machines – took over, producing heavy selling.
The Journal, citing multiple trading sources, even said a major firm may have accidentally released an errant program, where a trader accidentally placed an order to sell $16 billion, instead of $16 million, worth of e-minis, the futures contracts tied to equity indexes.
This kind of fat-finger mistake and algo-gone-amok environment is exactly what the financial industry has been trying to avoid–now to seemingly little avail.
At a panel that began at 2:15 p.m., in the midst of the steepest part of the plunge, another DTCC executive was telling his audience that the financial industry had done a dismal job of taking charge of the reform debate – and blocking reform that did not make good operating sense.
The industry needed to stop being the "tail" on the discussion and instead become the "dog," Robert M. Hegarty, the managing director until recently for market structure at the DTCC, said. He is now in a strategic and marketing position.
At that panel, well-known industry analysts Larry Tabb of Tabb Group and Sang Lee of Aite Group said all the reforms being pushed are likely to require big investments by securities firms in technology and operational costs. Costs which will be passed on to customers, in trading fees, or take a chunk out of profits. Or both.
Tabb said the industry had "misplayed the whole issue from soup to nuts." And Hagerty said the "most efficient" answer was for the industry to get together and institute meaningful reforms on its own, in ways that conserve capital.
Which seemed like a grand idea just 24 hours ago, when DTCC chief executive Donald F. Donahue proposed at this conference that the industry create a Capped Contingency Liability Facility that would handle the simultaneous collapse of multiple firms, without member firms having to put up tens of billions of dollars into an emergency fund, upfront. That was one of the proposals in the Senate bill, that only came off the table this week.
Under Donahue’s plan, all DTCC member firms would cover the cost, when the emergency actually came. And, because it could calculate the need with a high degree of accuracy, the DTCC would see that a cap was placed on the members’ liability, as positions were unwound from the failures.
Aaah, that seems so long ago, at this SiFMA OPS. And even the hopes of the panels at 10 a.m. and 11:15 a.m. today, local time, seem such distant memories of an era gone by.
Because of a poisonous combination of incalculable systemic risk, human emotion and the superspeed of electronification of markets, whether code worked well or whether it went amok, operations and technology executives have lost control of the debate on what changes they will have to implement in coming years, once again. Maybe forever.
The reformers are coming. Here. Abroad. And, just as with the big bonuses in 2009, and as with the big profits in 2010 from companies that needed tens of billions of dollars of taxpayer money to stabilize themselves and their counterparties in 2008, the fire has been lit once again.
And there seems no fire-fighting crew ready to douse it.
The story originally appeared on the Web site of Securities Industry News, a sister publication of Traders Magazine.
