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More on the Crash of 2:54 p.m.

Still curious as to how the Dow plummeted by 1,000 points in a matter of minutes yesterday? A big part of the answer appears to be that various automated trading programs, high-frequency trading technologies and assorted other innovations meant to make traders richer the market more liquid basically began eating each other. The fun part? No one seemed to predict that this could happen, and no one's even sure if it did happen. Kevin Drum comments:

Quite aside from the merits of the HFT controversy itself, this is symptomatic of an overall problem that we've all become pretty familiar with lately: the people in charge of financial markets don't really know what they're doing anymore. In the derivatives industry, they created securities so complex that no one understood them and no one understood just how interconnected and dangerous they'd become. In the trading industry, a combination of ECN-based dark pools, HFT algorithms, and God knows what else have created a trading environment that no one truly understands and no one can control. Obviously markets can boom and crash just fine without these innovations, but they can sure boom and crash a lot bigger and a lot faster with them.

Felix Salmon takes the opportunity to make one of my favorite points: "There’s a very sensible idea going around that a simple way to deal with nearly all of these problems, at a single stroke, would be to implement a tiny tax on financial transactions. Historically, people have complained that such a tax harms liquidity, which is true. But the fact is that it harms the bad kind of liquidity — the liquidity which dries up to zero just when you need it most... Let’s tax it, and raise some money for the public fisc at the same time as slowing down markets and making them think before doing a trade."

By Ezra Klein  |  May 7, 2010; 4:14 PM ET
Categories:  Financial Regulation  
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I have been advocating the financial transaction tax targeted at computer arbitrage trading and hyperfast equities trading and a tax on naked derivatives trading for since 2008. I didn't know I was in such good company.

Posted by: srw3 | May 7, 2010 4:40 PM | Report abuse

actually, this is pretty much what happened in the '87 crash, which taught those of us old enough to remember that markets could, in fact, fall 22% in a day, no sweat....

Posted by: howard16 | May 7, 2010 4:42 PM | Report abuse

I know some people that write HFT algorithms. You need to understand math, finance, coding, networks and trading systems very well. These skills are probably pretty rare to find in a single person and I doubt there are very many individuals that can understand all aspects of the process, only bits and pieces. I'm not really surprised that there would be odd bugs that make the things go wacky when the right set of circumstances hit. After all, what software is ever entirely bug free?

Its just that instead of having to force-quite an application, millions of people lose their retirement savings in a matter of minutes.

Tis a shame we didn't privatize social security back in 2005, right?

Posted by: nylund | May 7, 2010 4:58 PM | Report abuse

"The fun part? No one seemed to predict that this could happen, and no one's even sure if it did happen."

I already commented in the thread below an earlier post on this topic that it does not inspire confidence that the NYSE evidently lacks the technological ability to quickly verify or dispel the theory that the plunge and recovery was caused by some "fat finger" trade error from a single source.

You'd think we would at least be able to get a clear answer to that question on the same day as the event, given the very narrow window of time within which the entire event took place.

Posted by: Patrick_M | May 7, 2010 5:03 PM | Report abuse

It's moments like these that I'm reminded why Gene Fama should never be allowed near a Nobel Prize. Efficient markets are a joke.

Posted by: jeffwacker | May 7, 2010 5:09 PM | Report abuse

What Howard said (although I am no older than Ezra) - high frequency automated trading was blamed for the 1987 crash.

Ezra, you don't need to cross out that the innovations were meant to make traders richer. I don't think pro-market people would deny that - pro-market people just tend to emphasis that a positive externality of more trading is more liquidity - invisible hand stuff.

A financial transactions tax does seem to make sense. Better than taxing labor in any case.

Posted by: justin84 | May 7, 2010 5:18 PM | Report abuse

My worry about the transactions tax is that doesn't it, almost be definition, distort the market, skewing the accuracy of market information about where resources are being allocated? A study by Garbner in 1996 showed the spreads on Euro-Dollar exchanges can be as little as 0.00001, so any tax higher than that is likely to render the market's EUR-USD exchange rate inaccurate. And that doesn't sound like a good thing to me.

Posted by: bigmandave | May 7, 2010 5:37 PM | Report abuse

"Historically, people have complained that such a tax harms liquidity, which is true."

Here are my comments on this (slightly modified) from last November:

I think that the tax, as I've seen it proposed, is very small, insignificant for someone who's cashing in retirement savings accumulated over decades, or even just years, or weeks for that matter (although a layperson should never be speculating with regular frequent trades). What it is to discourage, as I've heard it, is things of little or negative social value like high frequency trading and market manipulation. It appears as though it would be too small to a have much effect on positive market activities.

Empirical research of this tax is easy in at least one way. For most of the market history transactions costs were as expensive, or much more, than with the tax just due to the higher costs of not having the computerized, high tech comunications and administration.

With regard to liquidity effects, small retirement investors should not even think of trading something illiquid enough that this small tax could have much effect. Clearly this small tax would have no significant effect on the liquidity of something like a Wilshire 5000 tracking Fidelity mutual fund.

Again, look at stocks and funds 20 years ago or more, when transactions costs were much higher than they would be today even with this tax. Was there much liquidity problem for major funds? No, not at all, not even for any major exchange traded single stocks.


Posted by: RichardHSerlin | May 7, 2010 6:18 PM | Report abuse

"In the trading industry, a combination of ECN-based dark pools, HFT algorithms, and God knows what else have created a trading environment that no one truly understands and no one can control."

If someone could control it, that would be very, very wrong. In fact, that's the epistemic fallacy of the progressives neatly stated. They think they are smart enough to control everything.

The bigger point in here is that there are simple things that happened. Given recent volatility, I had a very tight set of stop loss triggers on investments. The dangerous aspect of stop loss triggers is that if demand appears to drop off completely, let's say due to an error on one of the exchanges preventing visibility of buy orders, the stop loss order still stands, dropping the offering price continuously until a buyer appears.

What can happen is more along the lines of sell orders without a bottom from NASDAQ catching an interruption in the buy order flow and pricing data from NYSE, and letting the price fall until buyers appear.

The interconnected nature of the IT systems here, and the crazy timing effects they create between each other forms a complex system. "The mode of failure of a complex system cannot be predicted from its structure" - John Gall

Posted by: staticvars | May 7, 2010 8:33 PM | Report abuse

Money McBags has had it with the market being manipulated by HFT.

Posted by: moneymcbags | May 7, 2010 10:31 PM | Report abuse

Witches, they are all witches, they are making our children sick and our crops wither!

Emergent behavior in markets is a fascinating subject and an active area of research. There was never a class of people who made sure that the markets behave properly. There were always crashes and panics. Nobody ever knew how markets behave, nobody was ever in control. We know today more than ever, that's about it. Adding tax won't change anything, it may make things move slower, but not nearly as slow as in 1929, or in any of the many bubbles and crashes over the past four centuries, which of course was during the good old times when somebody was in control, right? If anything, you want things to move even quicker than today.

How come nobody came out and said how amazing it is that a network so complex rebounded so quickly and completely? When did that ever happen? In 1987? Nope, it fell farther and took about a year to come back.

There's a lot of nonsense being said by people who don't know the first thing about what they're talking about.

Just keep the people with degrees from Harvard Law from going around screaming things like "the worst crisis since the great depression" and we'll be fine.

Posted by: mmio | May 8, 2010 1:07 AM | Report abuse

And can all the idiots please stop differentiating between trading with "social value" and without, like that is something that anybody has ever defined so that it makes sense?

I grew up in a communist country where you had the smartest of the smart people determining what's of social value and what's not so efficiently that we saw how that worked out. It makes my skin crawl listening to everybody from our beloved political class these days. I'd expect any boy who ever traded baseball cards, or even a Chinese peasant, to have a better understanding of trading than Levine exhibited. And he's a senator of the country that's supposed to be a beacon of capitalism? Scary.

Posted by: mmio | May 8, 2010 1:27 AM | Report abuse

"No one seemed to predict that this could happen, and no one's even sure if it did happen."

The awful truth is that since automation was involved, by definition, the results WERE absolutely predictable and the source IS absolutely knowable, regardless of the perceived complexity of the system. The fact that, at present, regulators do not know the source and cannot reproduce the behavior merely underscores the inefficiency and inappropriateness of the regulatory scheme: until the automated schemes are brought into full light, the same problems will recur, to the financial benefit of the few who know

Mark Warner, a Democratic Party member speaking on Fox News Friday evening, offered some suggestions: as both a key player in CapitalOne and as an individual having true technical savvy, Warner has some keen insights.

Posted by: rmgregory | May 8, 2010 10:43 AM | Report abuse

Of course it was predictable. For goodness sake, it happened less than 20 months ago to United Airlines. Google News grabbed an old story from UA's archives, posts it on the Google News front page, automated trackers grab it, and rapidly begin selling off UA stock. Who woulda thunk it that it would happen again?

Well, probably everybody.

Posted by: erikharrison | May 8, 2010 12:31 PM | Report abuse

Perhaps a bit more than a small tax on purely machine generated trading might be a good idea. The algorithm all seek to see changes in the market to exploit faster than human traders can, expecting to get in firstest and fastest and get out the same way. In electronic systems that produces the shrieks rockers love to generate by aiming the acoustic pick ups on their guitars right at their amps. In systems where such shrieks can't be permitted, the systems are loaded with resistance and provided with sufficient negative feed back to damp the exponential rises that produce the distortion.

Securities traders value the shrieks, hoping to be their right at the start and to get out before the feedback blows the over driven amp.

So taxes, which are resistive loads, margin requirements, which are reactive loads equivalent to capacitors, and trading delays, which are the market equivalent of inductive chokes, can all act to prevent market thermal runaway, overdrive, and failure.

Loading resistances ion the order of 10% of the working load tend to be a reasonable compromise, so a 10% tax on profits from machine generated trading might not be a bad place to start.

Posted by: ceflynline | May 8, 2010 1:44 PM | Report abuse

Is it true that on the day of the stock crash, Bernie Sanders and the Dems capitulated and thereafter weakened the FinReg proposals as a result of the crash?

Could it be Wall street and other high level power brokers intentionally caused that crash as a means to coerce and scare the Senate into backing off its plans to break up banks and audit the Fed?

How is it the US knew who the 911 hijackers were the day after 911 and yet we still have no clue what caused this stock crash?

How is it one of Obama's best election bragging points (rising stock market over the last year) is erased in 15 magic minutes?

As you recall, the original anthrax scares against Tom Delay and other Dems seemed to be timed to help ensure their submission regarding passage of the patriot act.

Here are some other curious coincidences: oil prices dropped quickly just before the 2006 and 2008 elections, but trended higher at all other times between 2001 and more recently. Even now, before the midterms, oil prices are again ticking upward.

And lest right-wingers call me a conspiracy theorist, I just spent an 11 day trip visiting conservative family members around the eastern seaboard suffering through their theories that environmentalists blew up that gulf oil rig, and that Obama is a socialist kenyan who has raised taxes on everyone.

I don't believe in coincidences and there's been far too many in recent years. Trillions of dollars are at stake with these reforms, and history proves that greed is abundant and greedy men will do anything to get rich or maintain their ill-gotten wealth.

Posted by: Lomillialor | May 8, 2010 11:25 PM | Report abuse


Yes, you are and you family are conspiracy theorists.

2nd, Obama is not a Kenyan or a socialist, he's a Keynesian. That's the real problem.

Posted by: staticvars | May 9, 2010 12:37 AM | Report abuse

Here's some proof that big business games the energy markets. See link below how CA's AG successfully proved it in court.

So yes, some conspiracies do exist. The trick is figuring out which ones are real. So tell me, did the Dems and Sanders, or did they not, weaken the FinReg proposals after this week's crash? And has anyone in the gvmt figured out what caused it? After you have your answers, then call me a conspiracy theorist.

Posted by: Lomillialor | May 9, 2010 7:03 AM | Report abuse

Here's another conspiracy theory: an agency of the US gvmt is allowed to run in almost complete secrecy and allocate or spend trillions of dollars in any way it chooses without having to report to Congress or the President what it did with that money.

Another: a well-known investment advisor with unique access to the federal gvmt and the SEC has been operating a $65 billion ponzi scheme since the 1980's and not one person near to him in the fed gvmt who knew of his amazing and impossible success ever suspected anything.

Another: A relatively small number of speculators actually control oil prices. This can't possibly be true. We've been told for years the markets do that.

Another: environmentalists are responsible for the decline in the number of US oil refineries, and the lack of new construction of such, in the last 30 years. This is the official story according to the MSM, even though it is completely and provably untrue.

If anyone thinks last week's crash is purely coincidental, then you aren't truly aware how the power elite control things in this world. Ezra has admitted no one really understands how the financial system works, and that means until someone can explain it, then you can't rule out that the system was designed this way for a purpose (max profit by hook or crook), and there is ample evidence this is the case.

Posted by: Lomillialor | May 9, 2010 7:26 AM | Report abuse

The argument against the transaction fee is that smaller traders, like regular people playing the stock market in the spare time, will be hit harder than giant firms that have billions to play with. It's a valid argument.

My solution is a progressive one, to have a ceiling for the number of trades per minute. Once you go over it, you get charged a % fee for every trade. Once you go over the next limit, that fee gets bigger.

Smaller traders likely won't get over the first hump, so they'll never have to pay the fee. Mid-sized traders might jump back and forth. But the manipulative algorithm computer trading will be stopped dead in it's tracks.

Posted by: TheBBQChickenMadness | May 9, 2010 8:48 AM | Report abuse

How come you don't have the intellectual courage to admit Greece had nothing to do with the crash?

Posted by: hariknaidu | May 9, 2010 10:05 AM | Report abuse

How come you don't have the intellectual courage to admit Greece had nothing to do with the crash?

Posted by: hariknaidu | May 9, 2010 10:05 AM | Report abuse

How come you don't have the intellectual courage to admit Greece had nothing to do with the crash?

Posted by: hariknaidu | May 9, 2010 10:05 AM | Report abuse

How come you don't have the intellectual courage to admit Greece had nothing to do with the crash?

Posted by: hariknaidu | May 9, 2010 10:06 AM | Report abuse

Oh, boy! A new tax...what a novel idea! Maybe we should tax "blogs"....say $.01 per word! Then maybe you, Ezra, would be more careful about what you have to say! Obama is a socialist....more taxes = more government = less freedom = more entitlements! America could become the new Greece if we don't get our "stuff" together!



Posted by: my4653 | May 9, 2010 10:07 AM | Report abuse

The stock market knew for months about greece and valuations already had greece into consideration. Greece had nothing to do with the fact that in 15 short minutes, on a day when the Senate was voting to break up big banks and audit the fed, and in a year when mid-term elections would be held, the stock market suddenly lost a year's worth of gains. This crash was a power play by as yet unknown players who were trying to terrorize the Dems into backing off their plans to wrest power from the elite.

Posted by: Lomillialor | May 9, 2010 10:47 AM | Report abuse


yes the stock market knew for weeks about Greece but only recently has it been seen as serious as speculation grew and Portugal and Spain's concerns grew.

And look at that the EU and IMF are bailing them out to the tune of about a trillion dollars and the market's back up 400 points.

I'm sure you'll fancy up another nice conspiracy theory for that as well.

Posted by: visionbrkr | May 10, 2010 9:57 AM | Report abuse

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