Wall Street: The Curse of the Fat Finger!

From the evil computer HAL in Stanley Kubrick’s film classic 2001: A Space Odyssey, to the sentient machines enslaving Keanu Reeves and his fellow humans in The Matrix, science fiction cinema has long explored the possibility that humans who create technology to serve their needs might find themselves at the mercy of technology run amok.

In fact, that plot line actually predates the rise of modern cinema. In The Food of the Gods, for instance, British novelist H.G. Wells wrote about chemically re-engineered food that helps carnivorous rats and wasps grow to giant sizes. And in Mary Shelley’s Frankenstein, a humanoid monster threatens his creator’s family in an attempt to coerce him into producing a monstrous female mate.

Last week on Wall Street, horrified traders witnessed a similar event: the computers that consummate equity transactions suddenly and inexplicably began closing sales at absurdly low prices. However, the market officials who purportedly control the machines were powerless to stop them; they remain perplexed about how and why the computers decided to destroy $700 billion of equity value in less than ten minutes.

Accenture for a Penny!

The markets were already on edge when this calamitious event occurred; major indices across the globe had already dropped in value over worries about Greece defaulting on government bonds. Yet nothing prepared the traders for the manner in which their computers would suddenly seize control of the markets, establish irrational prices, consummate transactions, and then — just a few minutes later — suddenly relent and allow systems to return to normal.

How irrational were those prices? Proctor and Gamble (P&G), the manufacturer of consumer staples such as Ivory Soap and Crest Toothpaste, watched its stock price plunge from $60 to $39. Accenture, the global consulting firm whose stock had been trading above $40, suddenly saw its equity priced at a single penny. And index fund traders watched the Dow Jones Industrial Average plunge hundreds of points in a matter of minutes, all without any explanation or reason.

And then, just as suddenly and inexplicably, the markets returned to normal. Even while market guru Jim Cramer told CNBC viewers to just go buy Procter & Gamble, its stock price was soaring quickly. And Accenture’s stock prices climbed right back to the $40 level. But the computers never stopped consummating transactions; they remained in control of Wall Street’s essential trading function throughout the day.

Blame it on a Finger!

At first, Wall Street analysts speculated that the entire event might have been caused by a single trader with a proverbial fat finger, someone who meant to trade a few million shares and then erroneously keypunched the sales order as a few billion shares instead. This explanation, though, did not address why the share prices of many companies dropped simultaneously; it was thus soon discarded, but not before Citigroup felt compelled to issue a formal denial about its own nimble fingered traders.

Then another explanation leapt to the fore, one that blamed the New York Stock Exchange for a control activity that was intended to reimpose human control over the computer trading systems, but that may have instead worsened the crisis. According to this explanation, when sell orders for the shares of P&G, Accenture, and other firms began to flood the markets, the Exchange followed its normal procedures and delayed the consummation of these transactions so that its human regulatory staff could confirm that the orders were appropriate. However, the computers that placed these sell orders at the Exchange on behalf of independent traders then followed their own control procedures and shifted their sell orders to third party computerized trading entities.

These third party entities operate outside of the regulatory oversight function of the Exchange; they were quickly overwhelmed with sell orders that could not be matched to buy orders. Eventually, as supply overwhelmed demand and equilibrium market prices dropped through the floor, a few intrepid traders jumped in and bought these stocks for bargain basement prices. Other traders followed suit and market prices quickly recovered, but those first few buyers were able to purchase quality equities at bargain prices.

Why Now? And When Again?

Although NASDAQ later announced that it would nullify certain trades that occurred during this period, market regulators remain at a loss to understand why this scenario unfolded at precisely this time, and whether it is likely to occur again.

At a time when government officials are castigating investment houses like Goldman Sachs for turning Wall Street into a highly risky casino, a place where immense profits can be won and lost on the basis of sheer luck, such events only feed the pervasive air of mistrust that surrounds the financial services industry in this post-recessionary environment. And such mistrust is likely to remain until regulators are able to explain precisely what happened during this week’s market crash, why it occurred, and how actions will be taken to prevent it from recurring in the future.