On Tuesday, the House Financial Services Committee will hold a hearing to find out what exactly happened on Thursday, May 6, to send the Dow Jones Industrial Average diving 1,000 points in a matter of minutes.
This is perhaps the first time that a congressional hearing will actually be useful in financial fact-finding. The truth of what happened is buried among records of billions of Thursday trades. The New York Stock Exchange and Nasdaq, unable to publicly explain the cause, chose a “kill them all and let God sort them out” approach, cancelling thousands of trades.
The days since the plunge have been plagued with conflicting news reports, widespread suspicion about the power of computers, allegations of cyberterrorism and other species of rampant theorizing—all great material for conspiracy theorists and fans of The Matrix, but not as great for people trying to piece together why, exactly, the markets spiraled out of control.
Here is The Big Money's guide to the top five mysteries surrounding the market rout.
1. What caused it?
It is surprising that this should be the biggest mystery,considering that the New York Stock Exchange, Nasdaq, and the “dark pools” all run mostly on computers, which should make it easy to scan for an errant trade or evidence of a glitch. Almost everyone agrees that, at some point, computers programmed to trade at certain prices took over and magnified the problem. But what caused the problem? As a Wall Street Journal headline so eloquently put it, “regulators can’t name cause of market slide.”
So for the primary mover, we’re worse off than not knowing: We’re getting vastly conflicting accounts. The only real piece of information to come out from five days of investigations is this: It probably started with “aberrations” in Chicago. The Chicago Mercantile Exchange, however, is somehow positive it wasn’t a cyberattack.
Initially, rumors held that a trader (in Chicago, perhaps) had a thorough interview with a trader speculating on how that would work. He makes a compelling case.
Unfortunately, in a vacuum, every case sounds compelling. The Wall Street Journal took a stab at creating a thorough forensic timeline and traced it back to several big trades in Proctor & Gamble (PG) stock. The Journal built a compelling case. But later, “government officials” and those “familiar with the investigation” told the New York Times that trading in Procter & Gamble was almost certainly not the cause. Similarly, Politico reported that the “e-mini” explanation is currently in vogue with regulators.
It’s also impossible to find out when exactly the crash started. The New York Times and WSJ go with 2:40 pm. CNBC calls it the “Crash of 2:45.” The Wall Street Journal’s Deal Journal pointed out that trading volume moved up at 2:30 p.m., and that the NYSE Arca tripped some switches at 2:37 p.m. Considering that there are hundreds of thousands of trades each minute, that seemingly small distinction is important.
2. Why has no one come forward to take responsibility?
The problem with the “fat-finger trade” theory is this: No firm or person has claimed that the trade was theirs. In fact, several firms, including Citigroup (C) and Terra Nova Financial, issued categorical denials. Refusing to take responsibility is highly unusual behavior for trading firms: especially in a market crash, it looks particularly craven. To some, the blankness of the faces involved is a good argument for more regulation of “dark pools” that trade securities far away from the prying eyes of the exchanges. But this blankness is also the primary reason that some suspect either market manipulation or cyberattack.
3. Why did the exchanges cancel trades if they insist there was no glitch?
The New York Stock Exchange and Nasdaq both denied that there was any technological glitch in their trading, meaning that the bizarre trades were due to forces outside their control. The exchanges could be telling the absolute truth, or they could be avoiding some embarrassing assumptions people might make in light of past, similar technological problems. (Both exchanges have histories of pricing glitches and blackouts.) Nonetheless, both exchanges unilaterally decided that they would cancel all trades in stock whose prices changed more than 60 percent. This is the largest single cancellation of stock trades in history.
To traders, this makes no sense: If there were a provable glitch, the cancellations would be fine. But if there was no technical glitch and the system as a whole was just doing its job, then the exchanges interfered with bargain shopping.