Friday, May 7, 2010

The Markets' Mini-Meltdown

Dear Readers,
I live with a recovering investment professional.  Days like today remind me why I am glad that he is a retired person.  I am going to expound on the situation, and hope that you don't decide it's boring or too complicated and click away.  I'll add parentheticals and italicizations (have I just coined another word?) and try to make it as plain as I can.  But I was laughing so hard by the close of business today that I just had to share the joy. 

 Procter and Gamble's stock took a little tumble towards the end of trading today.

As the graph so eloquently depicts, something happened at 2:4opm.

There it was, tooling along in the area of $60 a share when suddenly there was a trade at $39.
A trade = a buyer and a seller.

Almost immediately, the entire market followed suit.

The lines represent the Dow, the S&P 500, and the NASDAQ Composite indices. 
If you don't know what that means, feel comfortable looking at it and seeing the way business went for the major players in the stock market today.

How can this happen, you ask?  Well, Dear Readers, it's a two part question, even if you didn't know it when you posed it.  And I, Ashleigh Burroughs, am here to present my theories.
As I said, there are two pieces to the inquiry: 
  • Why was there a trade at $39?
  • Why did one trade cause the entire market to fall down the rabbit hole?
The answers have a lot to do with the way stocks are traded these days.  Indulge me, if you will, as we travel down memory lane.  There have always been markets, and until very recently they were human-to-human interactions, kind of like this scene from Trading Places, minus the violence:

An oft-told Wall Street story is that of Gus Levy, Goldman Sach's entire trading department in the 1930's, carrying trade tickets in the inner brim of his hat as he made the rounds of his clients before heading to the floor of the New York Stock Exchange to begin his day.  Teletype machines (ticker tape parades were literally that: the strips of paper recording the day's trades came out of the machines and were tossed on the heads of dignitaries) and telephones added a layer of distance between the trading floor and the brokers and their clients.  Then came the computer, with its massive capabilities and an ability to act on its own.

Well, ok, not really on its own, but let us look back to your second question, grasshopper, and discover why the entire market followed one stock's plunge.  Computing power allows investors to create automated trading strategies based on the performance of the markets over time and historical events and, I don't know, the weather maybe.  There are algorithms which take into account variations in the behaviors of certain stocks, or sectors of the market, or, who knows, the phases of the moon and which are fine tuned to recognize and recalibrate when things change, no matter how minutely. These programs are authorized (here's the "on its own" part) to send trading instructions to the market floor.  

Here's where the fun starts.  Since there was no human being to say "What is going on here?  This isn't right/rational/logical?" when the trade was made, it went through smoothly.  Immediately, the automated programs began to incorporate this precipitous drop into their calculations and presto, change-o, alakazam kazowie, the leading indicators were on their way down, too. 

The panic didn't last long (the graph makes it seem like 20 minutes or so), and the talking heads were saying that the situation in Greece and Spain and the future of the EuroZone and the euro itself added to the stress, but they were shaken by the event.  

And what was that event, you might ask?  We are now back to Question #1 -- $39?????  And here's what I think:
Somewhere, at a trading desk, sits an order taker or a clerk or an assistant or associate.... some poor soul who is having a true Steve Urkel moment.

Or, as Sarah says to Chuck in episode 14 of season 3  (thanks to the Big Cuter for this reference), "I made an oopsy."

I picture this kid, staring blankly at his screen, waiting for the inevitable shoe to fall on his head, wondering how he could have keyed in 39 instead of 59.   Somehow I don't think a simple "My bad" will suffice.  

This is a happier solution for me than the only alternative I can conjure up: cyber terrorism.  Someone tried to blow up an SUV and half of Times Square on May Day, after all.  It's certainly within the realm of possibility that a bad guy hacked into a mainframe somewhere and tried some economic terrorism.  Perhaps this was a test run.  Perhaps not.  But I am happier with the typing mistake solution.  It helps me sleep at night.

We've seen a lot of evidence of the power of machines to wreak havoc with our financial system over the past year or two.  Given the ability to crunch the numbers, the quants were able to create investment vehicles which were arcane to the point of incomprehensibility.  All anyone really knew was that they were making money.  Lots and lots of money.  Until someone noticed that giving a $600,000 mortgage to a child care worker clearing $40,000 a year might lead her to default on that obligation.  Thus were born the credit default swaps, those bundled securities whose value Goldman Sachs is accused of betting against.  That is fodder for another post (stay tuned) but the basic premise is the same.  The machines really shouldn't be managing the store.  

Remember HAL?