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How Wall Street has changed since the flash crash
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Tess Vigeland: One year ago tomorrow — May 6th to be exact — the Dow Jones Industrial Average plunged hundreds of points in minutes, and within half an hour, nearly a thousand. It was the biggest one-day point decline in history and became known as the “Flash Crash.” It was only a flash because before the day was through, the market recovered nearly all its losses.
For months, regulators struggled to explain what had happened and why. We know now that the slide was caused by several factors, but primarily by one trade worth billions of dollars that set off a computerized cascade of sell orders. What’s been done to fix what ailed the trading floors that day?
Mary Schapiro is chair of the Securities and Exchange Commission and she joins us from her Washington office. Welcome to the program.
Mary Schapiro: Thank you. It’s a pleasure to be here.
Vigeland: Let’s get right to the question I think on many investors’ minds, which is: Can this happen again?
Schapiro: Well let me say that while we can never say it can never happen again, we do think we’ve taken steps that really address the issues that were raised. So for example, by putting in place circuit breakers that stop a stock from trading if its price moves more than 10 percent in five minutes. We’ve eliminated the ability of stock prices to cascade down the way they did on May 6th of last year. We’ve eliminated the ability for stocks to be traded at what we call “stub quotes” or “penny prices.” And we continue to work on additional initiatives to try to bolster the resiliency of the markets. So I think as a result of our actions, we have significantly reduced the likelihood of a similar event ever occurring again.
Vigeland: You mention the circuit breakers, and I know that recently, one of the fixes that’s been explored is something called a “limit up, limit down” rule. What is that, and how is that different?
Schapiro: That’s exactly right. What “limit up, limit down” does, it really becomes a precursor to the pause in the marketplace that the circuit breaker gives us. And so what it would do would be to prevent an order from even being entered into the market at a price too far away from the actual market price of the stock. So that we wouldn’t have the possibility for erroneous trades to begin a market’s rapid decline, the way we saw on May 6th. Not that the May 6th events were an erroneous trade, but that’s certainly still a possibility.
Vigeland: You know, part of what made the flash crash so worrisome for a lot of investors is that it took a long time for regulators to figure out what happened and why. And you know, the lack of an explanation was, in some ways, worse than the actual event. Is your ability to track this kind of thing better now than it was a year ago?
Schapiro: Well, you know, it did take us several months to be able to reconstruct on a second-by-second or microsecond-by-microsecond based on what happened on that day. We did publish two very full reports that I think helped people to understand exactly what happened. We have also proposed here at the SEC to have a consolidated audit trail system that would give us the tools to reconstruct trading after events like a May 6th much, much more quickly. We’re not there yet, but I think we will get there and we will be able to give people complete answers a little bit more quickly in the future.
Vigeland: I think there’s a sense that for the most part, people were not hurt by the flash crash because the markets did recover, as you pointed out. But we’ve heard from listeners who, for example, had stop-loss orders in effect, so the system automatically sold during that period where stocks were dropping, and you know, some of them ended up with, for example, huge tax bills this year because of that. Is the message to individual investors that they just have to factor in this kind of possibility into their risk tolerance?
Schapiro: I think investors were very profoundly impacted, and you know, 20,000 trades had to be cancelled, and many more investors sold at unreasonably low prices whose trades weren’t cancelled. And it clearly impacted investor confidence. My view of this is investors should understand that when they buy and sell stock, they take a risk in the investment value of that stock going up or down, and that’s a risk they can understand and that they knowingly accept. My view is also, though, they shouldn’t have to accept the risk of frailty in the market structure, and that’s why we’ve taken the steps we have.
Vigeland: How concerned are you about a lack of investor confidence in the system? Given that something like this — in your own words — could happen again?
Schapiro: We continue to have, in the United States, the strongest and most robust capital markets in the world. But I worry about investor confidence everyday because our economy won’t grow, we won’t create jobs and investors don’t have confidence that they’re both getting the information they need to make good investment decisions, but that the playing field on which they’re transacting in stocks is one that provides them with access and fairness that’s important to the integrity of their investment decisions.
Vigeland: Mary Schapiro is chair of the Securities and Exchange Commission. She has joined us from her office in Washington. Thank you so much.
Schapiro: Thank you.