By Heidi N. Moore
Sunday, May 16, 2010; G02
On Tuesday, the House Financial Services Committee held a hearing to find out what happened May 6 to send the Dow Jones industrial average diving nearly 1,000 points in a matter of minutes.
Here's what we learned: There was no one and nothing to blame. We were led to believe that everyone and everything was doing its job and that the market crash was an effect of too much efficiency.
The truth of what happened will remain buried among records of billions of Thursday trades. The New York Stock Exchange and Nasdaq, unable to publicly explain the cause, chose a "kill them all and let God sort them out" approach, canceling thousands of trades. To solve the issue, the exchanges will use the same approach, imposing circuit breakers on everyone. The theme of the hearings was unsatisfying: All for one, and one for all.
The days after the plunge were plagued with conflicting news reports, widespread suspicion about the power of computers, allegations of cyberterrorism, and other species of rampant theorizing -- all great material for conspiracy theorists and fans of "The Matrix," but not as great for people trying to piece together why the markets spiraled out of control.
Five mysteries remain surrounding the market rout.
1. What caused it?
It is surprising that this mystery was not solved quickly, considering that the New York Stock Exchange, Nasdaq and the "dark pools" all run mostly on computers, which should make it easy to scan for an errant trade or evidence of a glitch. Almost everyone agrees that, at some point, computers programmed to trade at certain prices took over and magnified the problem. But as a Wall Street Journal headline so eloquently put it, "regulators can't name cause of market slide."
Worse than not knowing: the vastly conflicting accounts. The only real piece of information after five days of investigations was this: It probably started with "aberrations" in Chicago. The Chicago Mercantile Exchange, however, said it recorded no glitches or unusual activity. The White House doesn't know what caused it, either, but is somehow sure it wasn't a cyberattack.
Initially, rumors held that a trader (in Chicago, perhaps) mistakenly sold off an unusually large number of "e-minis," a type of futures based on the Standard & Poor's 500-stock index. During the hearings, Commodity Futures Trading Commission head Gary Gensler said that there were 250 trades in e-minis. Only one trade, however, was selling for a full 20 minutes -- from 2:32 p.m. to 2:50 p.m., accounting for 9 percent of all of the volume in e-minis. Yet Securities and Exchange Commission Mary Schapiro insisted that a "fat finger," or single mistaken trader, could not have caused the crash. The e-mini case sounds compelling, even so.
Unfortunately, in a vacuum, every case sounds compelling. The Wall Street Journal took a stab at creating a thorough forensic timeline and traced it back to several big trades in Procter & Gamble stock.
But later, "government officials" and those "familiar with the investigation" told the New York Times that trading in Procter & Gamble was almost certainly not the cause. Similarly, Politico reported that the e-mini explanation was in vogue with regulators. Later, the Journal theorized that a hedge fund associated with "Black Swan" author Nassim Taleb caused the crash. Few in the markets embraced the all-too-poetic explanation.
By Friday, reports emerged that Waddell & Reed, a brokerage and mutual-fund firm in Kansas, was identified as the mystery trader that sold a large order of e-mini contracts during the market plunge. However, the impact the trading in e-minis had on stock prices during the plunge remains unclear.
It's also impossible to find out when exactly the crash started. Was it 2:40 p.m.? Or 2:45? Maybe 2:30? 2:37? Considering there are hundreds of thousands of trades each minute, that seemingly small distinction is important.
2. Why has no one come forward to take responsibility?
The problem with the "fat-finger trade" theory is this: No firm or person has claimed that the trade was theirs. In fact, several firms, including Citigroup and Terra Nova Financial, issued categorical denials. Refusing to take responsibility is highly unusual behavior for trading firms: Especially in a market crash, it looks particularly craven. To some, the blankness of the faces involved is a good argument for more regulation of "dark pools" that trade securities far away from the prying eyes of the exchanges. But this is also the primary reason that some suspect market manipulation or a cyberattack.
3. Why did the exchanges cancel trades if they insist there was no glitch?
The New York Stock Exchange and Nasdaq denied that there was any technological glitch in their trading, meaning that the bizarre trades were due to forces outside their control. The exchanges could be telling the absolute truth, or they could be avoiding some embarrassing assumptions people might make in light of past, similar technological problems. (Both exchanges have histories of pricing glitches and blackouts.) Nonetheless, both exchanges unilaterally decided that they would cancel all trades in stock whose prices changed more than 60 percent -- the largest single cancellation of stock trades in history.
To traders, this makes no sense: If there were a provable glitch, the cancellations would be fine. But if there was no technical glitch and the system as a whole was just doing its job, then the exchanges interfered with bargain shopping.
4. Why can't the exchanges get their stories straight?
The New York Stock Exchange and Nasdaq are losing market share to electronic exchanges and upstart competitors. They also compete with each other and have a long history of smack-talking on the court.
It's probably no wonder, then, that the first reaction of each was to get into a hand-flapping tizzy blaming the other. Nasdaq blamed the NYSE for walking away from stock trading. The NYSE blamed Nasdaq and others for not jumping in when its own systems slowed down trading. The NYSE, resentful about the loss of many of its floor traders in the rush to technology, also used the excuse as an occasion to settle some scores, strangely insisting that the problem with all these computers is exactly why the NYSE needs to have floor traders.
Perhaps true, but saying "we need humans because our computers don't work" is not a solid defense. Besides, people didn't do great a job of reining things in, either.
5. What is the connection between the stocks that crashed?
There are almost no common characteristics among the biggest stock movers that day: Procter & Gamble is a consumer stock, Accenture is a financial stock; Boston Beer Company sells Sam Adams beer. The e-minis theory partially explains the connections because it's possible for unrelated stocks to appear in a single trading "basket."
In addition, it's unclear why exchange-traded funds, or ETFs, made up the majority, or 69 percent, of the canceled trades. That's too high a number to be a coincidence, but why these funds? It might be because most ETFs are created to track particular indexes, such as the Dow or S&P 500, which experienced wild swings. But as usual on this subject, answers -- not guesses -- are in short supply.
Bonus: Can this happen again?
We're assuming it can. But it would be nice to know for sure.
If Tuesday's congressional hearing could have clarified even one or two of these issues, it would have been a success. Instead, yet another hearing is being scheduled.
Heidi N. Moore, a financial journalist in New York City, is a former reporter for the Wall Street Journal.