Magazine article The American Prospect

The End of Capitalism! the Financial World and Its Would-Be Regulators Struggle to Understand the Flash Crash

Magazine article The American Prospect

The End of Capitalism! the Financial World and Its Would-Be Regulators Struggle to Understand the Flash Crash

Article excerpt


On May 6, the Senate was locked in a heated debate over whether the government should impose size limits on the largest banks in the country, in effect breaking up the reviled giants of American finance. But the journalists in the press gallery above the chamber weren't paying attention: They were riveted to CNBC, which was reporting an enormous, unexpected, and simultaneous plunge in several different global markets. On TV, the Money Honeys were losing it.

The Dow slid 1,000 points in less than an hour. "What the heck is going on?" one reporter wondered aloud. The Senate could break up the banks, and the markets are crashing? It's the end of capitalism!

But capitalism won't go down so easily. Predictably, breaking up the banks was a bridge too far for the stodgy Senate, and the provision only garnered the support of a third of the body. And within a few hours, the markets had recovered their value. Yet a question remained: Why did they plunge 9.2 percent in just a few minutes, only to recover before the day was over?

It's an important issue to resolve, because if we don't understand how our financial markets work, we have no reason to trust them. That is the end of capitalism.

So why the flash crash? There are as many answers as there are financial interests. For people concerned about the state of debt and deficit, the plunge was obviously a response to the Greek debt crisis: Rioters on the streets of Athens had inspired a massive sell-off in the U.S. A few supporters of financial reform wondered if this were an act of financial terrorism, a vigilante-style protest against financial reform.

The reform-averse made the opposite argument: The mini-crash was caused by Congress considering, even for a second, reining in large banks. The miniature panic, they said, proved that government intervention was dangerous.

On Wall Street, this is called "talking your book"-trying to get events to match up with the bets on your balance sheet. We're very familiar with the tactic in Washington, where we call it "spinning."

But the politicized explanations didn't have a wide appeal, and soon more divergent ideas emerged. The "fat finger" theory is my personal favorite; it holds that a trader accidentally hit "B" instead of"M" on his keyboard, selling off billions of dollars of Procter and Gamble stock rather than millions and catalyzing the freak-out.

There isn't much evidence this happened, but I rather like to think this is how these things start. Never blame malevolence when there is so much stupidity to go around.

Unfortunately, the Securities and Exchange Commission and the Commodity Futures Trading Commission released a joint report that "found no evidence that these events were triggered by 'fat finger' errors, computer hacking, or terrorist activity, although we cannot completely rule out these possibilities." The report did suggest derivatives called "e-minis" (which sound more like the latest Japanese children's toy than a speculative financial product) were at least partially responsible.

The heads of the two agencies testified before the Senate two weeks after the fact in an attempt to explain what happened. After about 45 minutes of discussing how different market safeguards failed, Sen. Jim Bunning--who has no business dealing with financial markets--suggested the protection measures were some kind of bailout. …

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