Flash Crash in India-Leads to Lack of Confidence In Markets Worldwide

Posted by Jeff Carter
on October 5th, 2012

The Indian stock market was down 15% in seconds last night. Kraft’s stock blew up the other day. In the US, people are fleeing the stock market. This is a massive problem. It’s deeper than just the messed up market structures that allow this to happen. The problem goes right to the heart and psyche of capitalist systems. The outcome could be frightening.

It’s frightening because when people lose faith in markets to set prices, the alternative is a fixed price set by a central planner. That leads to even more problems.

The stock market is not a casino. It is a place for speculation, but more importantly it’s a place for companies to raise capital to grow their businesses. It’s a place for people to increase their wealth. It’s a place for information about companies to be exchanged quickly and transparently. Electronic trading in some cases is making the marketplace a casino, but it’s important to realize that this isn’t the fault of electronic trading but the fault of poor regulation and poor structure.

If a building falls over, you don’t blame the occupants for putting too many heavy things on one side of the office. You don’t blame the piece of land it was built on. You blame the foundation and the structure. The idea of markets and the ways they interact is the “land”. The SEC, regulations and exchanges are the structure.

Speed and electronic trading are actually a nice development for markets if they are treated correctly. They broaden participation, make distribution systems more horizontal, and transmit information efficiently.

Like a quack doctor, legislators and the banks are trying to treat the symptoms without curing the disease. They want to keep the shell game alive because they derive so much profit from it. The current way we structure the stock market is anti-competitive. Payment for order flow, allowing participants to internalize order flow, and co-location give unfair edges to some, at the expense of the many. The average investor might just think, “so what if they shave a penny here or there”. That penny leakage is worth billions.

When electronic trading came, all of us knew that there would inevitably be errors. There were errors in the fully manual system! What we didn’t count on was the consistent magnitude of those errors, and how it would erode confidence in the free market system that humans count on to move innovation forward. That’s the gravest danger.

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.