Senators Kaufman and Levin’s The New York Times Op-ed on Preventing the Next Flash Crash

Edward E. "Ted" Kaufman, former U.S. Senator from the state of Delaware

Former U.S. Senator Edward E. "Ted" Kaufman (Wikipedia)

“ONE year ago, the stock market took a brief and terrifying nose-dive. Almost a trillion dollars in wealth momentarily vanished. Shares in blue-chip companies were traded at absurdly low prices. High-frequency traders, who use computers to look for microscopic price differences in stocks on different exchanges and other trading venues, stopped trading, while others immediately sold whatever they bought, mainly to each other, in what has been called “hot potato” trading.

We haven’t had a repeat of last year’s “flash crash,” but algorithmic algorithmic trading has caused mini-flash crashes since, and surveys suggest that most investors and analysts believe it’s only a matter of time before the Big One.

They’re right to be afraid. The top cop for our financial markets remains inexcusably blind to the activities of high-speed computer trading.

After the flash crash, the Securities and Exchange Commission moved quickly to apply a Band-Aid in the form of circuit breakers to limit daily price moves.  Then it proposed a long-overdue consolidated audit trail, to plug the gaps in reporting requirements that prevent the efficient tracking and policing of orders and trades. It spent months painstakingly using antiquated methods to reconstruct and study the trading data during the flash crash. With the Commodity Futures Trading Commission, it convened a joint advisory committee, which presented an array of recommendations in February. And it continued to dither.

Carl Milton Levin, United States Senator from Michigan

Carl Milton Levin, Senator from Michigan (Wikipedia)

Yes, both volume and volatility in the equity markets have been declining in recent months, but the centrality of High-frequency trading has not diminished. Moreover, High-frequency traders have gone beyond trading stocks to futures, options, bonds, currencies and other asset classes — and are making incursions in foreign markets. The next flash crash could be more pervasive than last year’s, as global asset markets become increasingly correlated through the convergence of computer-driven trading strategies.

In response, the S.E.C. should work with the C.F.T.C. to establish the audit trail, which would allow real-time monitoring of electronic trading; stop trading venues from catering unfairly to high-speed traders at the expense of regular investors; make High-frequency traders bear their fair share of the costs involved in heavy, instantaneous flow of electronic messages, which would discourage strategies to stuff the system with orders that are immediately canceled; and rethink rules that give too much priority to the rapid-fire orders that high-frequency traders rely upon.

More is at stake than the confidence of small investors. A survey by the consulting firm Grant Thornton shows that initial public offerings by small companies have declined over the past 15 years. The profits to be made in supporting small-cap stocks have dried up as Wall Street has focused obsessively on leverage and high-volume trading.

One promising idea being floated is an experimental market, with rules tailored to support the capitalization of the fastest-growing companies, many of them start-ups that are drivers of job creation.

America’s capital markets, once the envy of the world, have been transformed in the name of competition that was said to benefit investors. Instead, this has produced an almost lawless high-speed maze where prices can spiral out of control, spooking average investors and start-up entrepreneurs alike.

The flash crash should have sounded an alarm. Unfortunately, the regulators are still asleep.

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