The thing about the United States and its institutions, I’ve found, is that the research is excellent. When Congress or a government agency want to know what’s going on or how something works – they hire some really good people, give them a decent budget, a reasonable time-frame and good authority to get answers and the final product is generally good.
Unfortunately, once the regulators and politicians get ahold of this report, they ignore it and pursue their own idiotic agendae; or the agendae of those who appointed them.
And so it is with the Flash Crash. The Flash Crash report was really good, but now Gary Gensler, a political hack who knows which side his bread’s buttered on, has given a ridiculous speech about possible new rules:
Gensler, speaking today at a conference in Washington, said brokers using computer algorithms might need to face limits on price or the size of orders they can execute for clients. He also questioned whether market participants might benefit from “fuller visibility” of exchanges’ order books.
The CFTC and the Securities and Exchange Commission said in a report last week that a large trader’s attempt to hedge against losses helped set off a chain of events that sent the Dow Jones Industrial Average down 998.50 points on May 6. The trader, who tried to sell 75,000 futures contracts worth $4.1 billion, used an algorithm that gave no regard to price or time.
“The large customer did not execute the trade itself, but used an executing broker,” Gensler said at the Wholesale Markers Brokers’ Association meeting. The event raises questions about whether brokers should “have to adopt certain trading practices when executing a large order,” he said.
Participants in the futures market can only “see up to the tenth offer or bid in an order book,” Gensler said. Liquidity might not have been so “overwhelmed” by a single, large sell order on May 6 if traders had more transparency, he said.
This is insane. The last paragraph is contrary to everything we know about markets. There have been countless studies on the effect of TRACE and of opening access to order books that show that increased tranparency leads to a thinner, more brittle market. Making the order book more accessible will increase the chance that a single dumb order can overwhelm the market, not less.
Additionally, setting the brokers up to police whether portfolio managers’ orders are good enough is just a dumb idea. In the first place, it assumes that brokers are smarter than portfolio managers – a highly dubious assumption – in the second place it adds another layer of red tape to the investment industry, leading to decreased efficiency.
The Flash Crash was caused by a bozo trader taking a huge market impact cost. A few tweaks to the rules seem indicated, but market impact happens every single time an order is executed. Given that there is far more “real money” in the markets than “hot money”, there will, from time to time, be market paroxysms that don’t make much sense. The Flash Crash was unusula only in its size – but Gensler wants to make life safe for the incompetent.
[…] takes this as an indication the executing broker should have refused or adjusted the trade and is musing about increased regulation that would force brokers to take responsibility for their clients’ orders. I think this is […]