The Frankenstein of Capitalism
Published in La Stampa
(Italy ) on 15 May 2010
by Francesco Guerrera (link to original)
The ten minutes of terror experienced by the New York Stock Exchange last week is a story worthy of the pens of Frank Kafka, Agatha Christie and Mary Shelley: a surreal mystery novel that revealed the defects of a system that everyone believed to be almost perfect.
The facts are known. On a nice spring afternoon, the Dow Jones index lost 10 percent before going up again in a just as violent manner and closing with a slight loss.
The problem is that ten days after this sudden fall, no one has been able to answer the question one of my colleagues asked me as soon as he set foot in the office after a 2:30 work lunch on that fateful day, Thursday May 6: "How?"
Big and small investors, from Syracuse, New York to Syracuse in Sicily, lost billions of dollars when the biggest stock market in the world transformed into an enormous yo-yo. But, the American government, the merchant banks and the operators of the stock exchange still don't know what happened.
A veteran of the American markets, whose voice still trembles when talking about black Thursday, made an interesting and disturbing analogy. "Imagine what would happen if the authorities said absolutely nothing after a plane accident. This institutional silence is terrifying." The usually well-informed are talking of a coarse error by an operator with "fat fingers" — someone who wanted to sell some stocks wrote billions instead of millions on the keyboard. Others lay the blame on the super computers that dominate the American and European stock markets — big brains that buy and sell securities at such a high speed that no human being can stop them. The pseudo-psychologists, instead, speak of the chronic insecurity of the markets that for months had to digest the bad news coming from Greece and other countries in the old continent.
But even if all these reasons were true, the New York stock market should have rules and infrastructures that don't allow them to act like a teenager with a passion for bungee jumping. The real loss undergone by American markets is much more serious than the financial liabilities of thousands of investors. In those 600 seconds of fire, the most famous stock market in the world lost the right to be the lighthouse of international capitalism, the metronome that keeps time for the global economy.
Sooner or later, the losses of Dow, Nasdaq and the thousands of little stocks that went to the bottom in those ten crazy minutes will be recovered. The law of the market is similar to the love story told by Lucio Battisti when he was singing, in "I would like ... I would not like ... but if you want,” of "daring descents and ascents/up in the open sky/and then down the desert/and again up high/with a big jump." The only certainty in the arcane world of selling and buying stocks is that a reductionist market — or in Anglo-Saxon jargon, the "bear market" — is always followed by a "bull market," in which indices rise and investors earn, or vice versa.
To lose face, however, for a market that depends on the trust of investors and operators is a little bit like losing one’s virginity: you can't go back. Like Larry Tabb, one of the gurus U.S. market analysis, said, "It is not so much that we don't know exactly what happened but that we know too well that the liquidity of markets we believed to be robust and solid evaporated in a flash.”
And if the stock exchanges of London, Hong Kong and Tokyo, the big rivals of New York, think that they can take advantage of misfortunes elsewhere, they are making a big mistake. The debacle on Wall Street had repercussions in the whole world (even oil, listed in London, fell rapidly that Thursday afternoon) and investors who were hurt by the leading market certainly will not move to ones that are more risky and less liquid.
The New York operators, at least the serious and intelligent ones, understood right away the seriousness of the situation. My spies in the seat of the New York Stock Exchange (NYSE) — the neo-classical building that dominates the corner between Wall Street and Broad Street on the tip of Manhattan — told me that the chaotic noise of the trading room turned into a dead silence when the Dow began to fall. In the headquarters of the merchant banks, operators that had seen everything remained shocked. "There was nothing to do; I remained there, with my mouth open, staring at a screen that had become completely red" said one of the most experienced traders for an American bank. In fifteen years of financial journalism on three continents, I have never happened to hear a confession of such sincere and desperate powerlessness.
The reason why operators went from protagonists to spectators of the convulsions of the market is due to the technological and structural revolution of the American markets in the last decades. The invention of stronger and stronger computers transformed the way in which investors interact with markets. Up until the mid-twentieth century, the New York Stock Exchange worked more or less how it had been set up in the 1792 "Buttonwood Agreement" — the pact between 24 brokers who met under a tree near Wall Street that created the nucleus of the first stock exchange.
The advent of super computers has made it so the market was able to deal with many more stocks, much more quickly and at such low prices (the base cost of a transaction has gone from an average of 12 cents to less than 1 cent) to permit millions of investors to play in the market. The "democratization" of the market happened at the expense of operators. If housewives in Wyoming could buy General Electric and IBM from their bedroom with the click of a mouse, what need is there for all the men in gaudy jackets yelling numbers and elbowing in front of a billboard full of numbers? And so, in the last ten years, human beings — loud, expensive and fallible human beings — were excluded from the financial whirlwind that we call markets. Nowadays, more than 90 percent of the orders executed in the New York Stock Exchange are automated.
At the same time, the relatively low prices of new technologies have facilitated the birth of alternative markets to the old Stock Exchange. Merchant banks have created "dark pools" — mini-markets that allow their clients to buy and sell stocks in private without revealing the price to their rivals. Other operators in the market, like Nasdaq, which at one time was dedicated to technology and telecommunications companies, have taken advantage of technological progress to offer treated stocks on the NYSE.
The result has been a fragmentation that makes it almost impossible for regulators, investors and operators to have a complete vision of the markets. In 2009, only 13 percent of the volume of the markets went through the NYSE.
As if this were not enough, the possibility of making money (a lot of money) using computers to take advantage of little discrepancies in prices between one market and another have pushed many generations of graduates in to math and physics to create very complicated algorithms to apply to the selling and buying of stocks. The speed with which these "algos” funds are acting has transformed them into the kings of the market. In a normal day, these investors without a face and without a clear strategy move about two thirds of the volume of American stocks.
The lack of common rules among all these actors is one of the reasons for the fall on May 6. In contrast with the NYSE, Nasdaq doesn't have a mechanism to "slow" the market when indexes fall — a difference that allowed investors who wanted to sell at all costs to get rid of securities at very low prices. And while the operators of the NYSE are obligated to receive orders in all conditions, the "algos" can withdraw from the market in moments of crisis, a factor that made liquidity evaporate and exacerbated the fall of the Dow.
The almost miraculous confluence of technology and big brains (whether computerized or human) has brought immense advantages to the U.S. markets, contributing to the growth of the American banking sector and consolidating the position of New York as the capital of global finance. But it has also given birth to a system so abstract and complex that it is almost impossible to oversee and cannot be stopped when it becomes unmanageable. As with the crisis of subprime mortgages, the passion of Wall Street for creating new and lucrative products has created a monster that its creators itself are not able to control. Instead of staring at those green and red screens, the operators should reread "Frankenstein," Shelley’s masterpiece, as soon as possible.
The facts are known. On a nice spring afternoon, the Dow Jones index lost 10 percent before going up again in a just as violent manner and closing with a slight loss.
The problem is that ten days after this sudden fall, no one has been able to answer the question one of my colleagues asked me as soon as he set foot in the office after a 2:30 work lunch on that fateful day, Thursday May 6: "How?"
Big and small investors, from Syracuse, New York to Syracuse in Sicily, lost billions of dollars when the biggest stock market in the world transformed into an enormous yo-yo. But, the American government, the merchant banks and the operators of the stock exchange still don't know what happened.
A veteran of the American markets, whose voice still trembles when talking about black Thursday, made an interesting and disturbing analogy. "Imagine what would happen if the authorities said absolutely nothing after a plane accident. This institutional silence is terrifying." The usually well-informed are talking of a coarse error by an operator with "fat fingers" — someone who wanted to sell some stocks wrote billions instead of millions on the keyboard. Others lay the blame on the super computers that dominate the American and European stock markets — big brains that buy and sell securities at such a high speed that no human being can stop them. The pseudo-psychologists, instead, speak of the chronic insecurity of the markets that for months had to digest the bad news coming from Greece and other countries in the old continent.
But even if all these reasons were true, the New York stock market should have rules and infrastructures that don't allow them to act like a teenager with a passion for bungee jumping. The real loss undergone by American markets is much more serious than the financial liabilities of thousands of investors. In those 600 seconds of fire, the most famous stock market in the world lost the right to be the lighthouse of international capitalism, the metronome that keeps time for the global economy.
Sooner or later, the losses of Dow, Nasdaq and the thousands of little stocks that went to the bottom in those ten crazy minutes will be recovered. The law of the market is similar to the love story told by Lucio Battisti when he was singing, in "I would like ... I would not like ... but if you want,” of "daring descents and ascents/up in the open sky/and then down the desert/and again up high/with a big jump." The only certainty in the arcane world of selling and buying stocks is that a reductionist market — or in Anglo-Saxon jargon, the "bear market" — is always followed by a "bull market," in which indices rise and investors earn, or vice versa.
To lose face, however, for a market that depends on the trust of investors and operators is a little bit like losing one’s virginity: you can't go back. Like Larry Tabb, one of the gurus U.S. market analysis, said, "It is not so much that we don't know exactly what happened but that we know too well that the liquidity of markets we believed to be robust and solid evaporated in a flash.”
And if the stock exchanges of London, Hong Kong and Tokyo, the big rivals of New York, think that they can take advantage of misfortunes elsewhere, they are making a big mistake. The debacle on Wall Street had repercussions in the whole world (even oil, listed in London, fell rapidly that Thursday afternoon) and investors who were hurt by the leading market certainly will not move to ones that are more risky and less liquid.
The New York operators, at least the serious and intelligent ones, understood right away the seriousness of the situation. My spies in the seat of the New York Stock Exchange (NYSE) — the neo-classical building that dominates the corner between Wall Street and Broad Street on the tip of Manhattan — told me that the chaotic noise of the trading room turned into a dead silence when the Dow began to fall. In the headquarters of the merchant banks, operators that had seen everything remained shocked. "There was nothing to do; I remained there, with my mouth open, staring at a screen that had become completely red" said one of the most experienced traders for an American bank. In fifteen years of financial journalism on three continents, I have never happened to hear a confession of such sincere and desperate powerlessness.
The reason why operators went from protagonists to spectators of the convulsions of the market is due to the technological and structural revolution of the American markets in the last decades. The invention of stronger and stronger computers transformed the way in which investors interact with markets. Up until the mid-twentieth century, the New York Stock Exchange worked more or less how it had been set up in the 1792 "Buttonwood Agreement" — the pact between 24 brokers who met under a tree near Wall Street that created the nucleus of the first stock exchange.
The advent of super computers has made it so the market was able to deal with many more stocks, much more quickly and at such low prices (the base cost of a transaction has gone from an average of 12 cents to less than 1 cent) to permit millions of investors to play in the market. The "democratization" of the market happened at the expense of operators. If housewives in Wyoming could buy General Electric and IBM from their bedroom with the click of a mouse, what need is there for all the men in gaudy jackets yelling numbers and elbowing in front of a billboard full of numbers? And so, in the last ten years, human beings — loud, expensive and fallible human beings — were excluded from the financial whirlwind that we call markets. Nowadays, more than 90 percent of the orders executed in the New York Stock Exchange are automated.
At the same time, the relatively low prices of new technologies have facilitated the birth of alternative markets to the old Stock Exchange. Merchant banks have created "dark pools" — mini-markets that allow their clients to buy and sell stocks in private without revealing the price to their rivals. Other operators in the market, like Nasdaq, which at one time was dedicated to technology and telecommunications companies, have taken advantage of technological progress to offer treated stocks on the NYSE.
The result has been a fragmentation that makes it almost impossible for regulators, investors and operators to have a complete vision of the markets. In 2009, only 13 percent of the volume of the markets went through the NYSE.
As if this were not enough, the possibility of making money (a lot of money) using computers to take advantage of little discrepancies in prices between one market and another have pushed many generations of graduates in to math and physics to create very complicated algorithms to apply to the selling and buying of stocks. The speed with which these "algos” funds are acting has transformed them into the kings of the market. In a normal day, these investors without a face and without a clear strategy move about two thirds of the volume of American stocks.
The lack of common rules among all these actors is one of the reasons for the fall on May 6. In contrast with the NYSE, Nasdaq doesn't have a mechanism to "slow" the market when indexes fall — a difference that allowed investors who wanted to sell at all costs to get rid of securities at very low prices. And while the operators of the NYSE are obligated to receive orders in all conditions, the "algos" can withdraw from the market in moments of crisis, a factor that made liquidity evaporate and exacerbated the fall of the Dow.
The almost miraculous confluence of technology and big brains (whether computerized or human) has brought immense advantages to the U.S. markets, contributing to the growth of the American banking sector and consolidating the position of New York as the capital of global finance. But it has also given birth to a system so abstract and complex that it is almost impossible to oversee and cannot be stopped when it becomes unmanageable. As with the crisis of subprime mortgages, the passion of Wall Street for creating new and lucrative products has created a monster that its creators itself are not able to control. Instead of staring at those green and red screens, the operators should reread "Frankenstein," Shelley’s masterpiece, as soon as possible.
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