October 1, 2010
This report details what went wrong on May 6 and, as many have guessed, there was no one culprit. The markets were skittish all day in large part due to the worsening economic news coming out of Europe. Volume and volatility were very high. By mid-afternoon, liquidity was drying up and sellers were having difficulty finding buyers. Then, when one institutional firm utilized an algorithmic trading program to sell 75,000 contracts valued at over $4 billion, the markets went into shock.
When that happened in one market, arbitragers moved to other venues and within minutes there was widespread disruption. The interrelatedness of markets exacerbated the problem and was a major lesson of May 6.
Now that we know what happened, we need to find ways to assure investors that it won’t happen again. Circuit breakers, limit-up and limit-down mechanisms and other “time-outs” need to be looked at so the markets can get back on track when things start to get out of hand. Liquidity restoration procedures need to be considered, too.
A handful of unhealthy things drove the markets into cardiac arrest that day. The structural changes we’ll make as a result of Dodd Frank will greatly help restore that health. At best, we need healthy regulation to keep that from happening again and, at worst, a defibrillator to get them started again when things start to go bad.
Last Updated: October 7, 2010