Last week's market dive largely caused by major Wall St. firms, SEC chief says

By Zachary A. Goldfarb
Washington Post Staff Writer
Tuesday, May 11, 2010; 5:13 PM

Major Wall Street firms retreated from the market last Thursday at the precise time when they were most needed to support normal trading, in what a senior federal regulator called the "most significant" factor behind the stock market's dramatic volatility.

Securities and Exchange Commission Chairman Mary L. Schapiro said several widely discussed causes of the violent swings in the market were unlikely to have played an important role. These include a "fat-finger" erroneous trade that started it all; hacking or terrorist activity; unusual trading in shares of Proctor & Gamble, a component of the Dow Jones industrial average; and futures trades linked to the Standard & Poor's 500-stock index.

In prepared testimony for a congressional panel probing the market turmoil, Schapiro said that firms known as "liquidity providers" stopped buying many of the stocks that were suffering the largest declines last Thursday.

Some of these firms -- which are part of major banks -- have an obligation under securities rules to act only in ways that stabilize the market. But other firms, which focus on make lightning-fast trades based on computer algorithms, do not have such obligations.

Some firms that had previously been active participants in the markets withdrew their liquidity after prices declined rapidly. Schapiro said these firms may have followed the rules in doing so.

But she added that regulators must reexamine whether liquidity providers should able to retreat from the markets at times of severe volatility.

Schapiro also said that disparate rules among exchanges for when to slow trades also contributed to the chaos.

Regulators from several agencies have spent the past several days analyzing millions of trades but have yet to determine what was behind Thursday's volatility. On that day, the Dow Jones industrial average rapidly fell nearly 1,000 points before rebounding 700 points, as many individual stocks suffered dramatic plunges before reclaiming most of their declines.

© 2010 The Washington Post Company