Roubine Global Economics has published an alarmist blog post titled The Flash Crash and Financial Terrorism: Could the Nineteenth Street NW Scenario Come True?:
But the SEC’s explanation is scarcely reassuring, and the incident is surely symptomatic of the pervasive market uncertainty.[1] That a single trade could wreak such havoc also raises the intriguing (and frightening) possibility of a deliberately engineered financial crash.
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A recent account, Nineteenth Street, NW, describes one possible scenario in which the terrorists use an off-shore hedge fund to launch a series of speculative attacks. The terrorists start with already weak currencies or markets—perhaps an overvalued currency or an under-financed sovereign[2]—and as they succeed in their initial speculative attacks, not only do they gain additional capital to launch their next attack, they also induce other (profit, not politically, motivated) investors to join the bandwagon of the next round of speculative attacks. In the story, the terrorists are also able to learn of the central banks’ FX intervention strategies (an issue of growing salience once more)—and plan a nasty surprise at a meeting of central bank governors and ministers to really spook markets. Eventually, given the interconnectedness of the global financial system, these cascading crises culminate in a global financial crash—costing trillions of dollars, and millions their jobs, homes, and life-savings.The account is purely fictional, of course, but as George Soros proved when he helped oust the UK pound from the European Exchange Rate Mechanism in 1992, weak fundamentals and jittery markets make for successful speculative attacks against even major central banks. And as the flash crash has amply demonstrated, markets are plenty jittery these days.
There’s so much here that is completely off-base I scarcely know where to begin. Terrorists launching speculative attacks via a hedge fund? Well, if they were that smart they wouldn’t be terrorists.
The Flash Crash caused 20 minutes of chaos, as the $4.1-billion market order swamped available liquidity, but the market quickly recovered. Dave Cummings estimates the cost of that adventure to be $100-million … and you can bet that the next twenty minutes would have cost more, given the lack of fundamental justification. Chaos inducing trades of this magnitude can only be done by sovereigns – China, say, the day before invading Taiwan. And in that event, you can bet the Fed would be involved, buying up Treasuries with fiat money as fast as the Chinese could sell.
Soros making a “successful speculative attack” in 1992? The UK owes Soros its heartfelt gratitude that he assisted in taking the pound out of the ERM. The attack was speculative, certainly, in the sense that there was no way of knowing for sure what was going to happen. But it would not have been successful had it been fundamentally unsound. What the events of September 1992 showed was that it was sterling’s position in the ERM that was unsound. Had they remained, the distortions would have spread from the financial economy to the real economy and things would have been, ultimately, much worse.
Which is the role of hedge funds and the role of short-trading: to yell that the emperor has no clothes. Politicians and global bureaucrats heartily dislike the entire process, because they’re the tailors. However, most of these attacks are unsuccessful because they are not based in fundamentals – they’re just chatter by wannabes.
The funny part about the essay is that the author acknowledges this:
Because the specific trigger is almost impossible to predict, crisis prevention efforts are better directed at addressing the underlying vulnerabilities. Quite simply, if there are no vulnerabilities, then a “triggering event” (deliberate or accidental) will have nothing to ignite, and will just fizzle out instead.
So who are the wise people who are going to make the system invulnerable, carefully ensuring that nothing bad can ever happen to anybody anywhere?
Starting from this premise, the Early Warning Exercise draws on a wide range of analytical tools, market information, and expert opinions. A key goal is to “connect the dots”—that is, understand how shocks in one country or market could spread across the global financial system. The findings are communicated confidentially to finance ministers and central bank governors at the IMF Spring and Fall meetings in order that they may take prompt preventive and corrective actions, especially those that require international cooperation and coordination.
Ah, yes, the IMF, perpetually on the prowl to expand its bureaucracy.
And who, you may ask, is raising the bogeyman of financial terrorism (as described in the novel Nineteenth Street NW) and pointing to the IMF as the saviour of the world? Funny you should ask:
Rex Ghosh is an economist with the International Monetary Fund and the author of Nineteenth Street NW (www.nineteenthstreetnw.com), a thriller about financial terrorism and a global market crash.
Roubini has demeaned himself by publishing this claptrap.