Still Waiting on Real Time Regulation 3 Years after Flash Crash, May 6th, 2010

Posted on May 2, 2013. Filed under: Exchanges, Flash Crash, Regulations, Securities, Securities and Exchange Commission | Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , |

The Speed Traders' Edgar Perez to CNBC's Oriel Morrison, Criticism of High-Frequency Trading Phenomenon Unfair

The Speed Traders’ Edgar Perez

On May 6th, 2010, the U.S. stock markets experienced an unusual decline (and an immediate upswing) that temporarily erased $1 trillion in market value (the Dow Jones Industrial Average plunged about 1000 points) and puzzled both actors and experts following the markets. Given the ongoing controversy about “flash orders” and its portrayed usage by high-frequency traders, this incident was quickly referred as the flash crash and just as quickly blame fell on the electronic trading industry. While it is true that some high-frequency trading firms stopped running their algorithms when the decline started (human traders stopped participating in the markets in Black Monday as well), some of them stayed in the market, and helped the markets recover just as quickly as the decline happened.

Fast forward two years and we find a twit from the Associated Press with supposedly breaking news that President Obama was injured due to explosions at the White House. That report made $136 billion in market value temporarily disappear, with the Dow Jones Industrial Average quickly dropping 150 points before swinging back.

Examples of dramatic swings can go all the way back to the origins of stock markets. We only need to take a look at Black Monday, October 19th, 1987, when the Dow Jones Industrial Average dropped by 508 points, 22.61%; by the end of October, stock markets in the United States had fallen by 22.68%, not showing any improvement for many weeks. Meanwhile, on May 6th, the Dow Jones had regained most of the drop only twenty minutes later.

Like major technology innovations in the past, computer trading was blamed for Black Monday back in 1987; as observed by economist Richard Roll though, program trading strategies were used primarily in the United States, and not in markets such as Australia and Hong Kong where the crisis started. Therefore, it is unsurprising by now that high-frequency trading has been blamed for the flash crash, the now called Twitter crash, and mini-flash crashes of certain stocks, commodities and currencies.

As Manoj Narang, CEO, Tradeworx, says in my book The Speed Traders, no matter what regulators do, there will be times when herd-like behavior among long-term investors will all be stampeding for the exits at the same time, and simply there won’t be enough high-frequency trading to cover the demand for liquidity. That is exactly what happened on May 6th, as described in painstaking detail in the CFTC/SEC report of September 30th, 2010; the report made clear that a mutual fund, identified by Reuters back in May 14 as Waddell & Reed Financial Inc., initiated a program to sell a total of 75,000 E-Mini contracts (valued at approximately $4.1 billion), certainly influenced by the pessimism in the markets due to street protests in Greece, among other reasons; the computer algorithm used to trade the position in the futures markets was set to target an execution rate set to 9% of the trading volume calculated over the previous minute, but without regard to price or time. Similarly, we will always experience technology and human errors. Dave Cummings, Chairman, Tradebot, would ask about the flash crash, “Who puts in a $4.1 billion order without a limit price?” That was the catalyst that initiated the flash crash. Knight Capital Group Inc.’s $440 million trading loss in August 1st, 2012, when the firm lost approximately $10 million per minute, is another recent example that comes to mind.

On March 7th, 2013, the U.S. Securities and Exchange Commission announced Regulation SCI (Systems Compliance and Integrity). As explained by Commissioner Luis A. Aguilar, the proposed rule would move beyond the current voluntary program and require entities to establish, maintain, and enforce written policies and procedures reasonably designed to ensure that its systems have adequate levels of capacity, integrity, resiliency, availability, and security to maintain the entity’s operational capability and promote the maintenance of fair and orderly markets, mandate participation in scheduled testing of the operation of the entity’s business continuity and disaster recovery plans, including backup systems, and coordinate such testing on an industry- or sector-wide basis with other entities, and finally make, keep, and preserve records relating to the matters covered by Regulation SCI, and provide them to Commission representatives upon request.

Electronic trading, like any other area of finance, should have sensible regulations imposed to promote sound trading practices and protect the average American investor from predatory behavior. If a market participant who does not use high-frequency trading believes that he or she cannot enter into fair transactions, then that individual will not invest in that market. But regulators could restore trust in the market without eliminating high-speed trading. They simply must be armed to analyze trading activity in real time.

In an area of finance predicated on speed, regulation must be as well. Real-time information would allow regulators to see everything that is occurring in the markets, no matter how quickly the order information is being posted and transactions are occurring. This would require significant commitments to invest in both human capital and information technology, but the investment is worthwhile: it is vital for regulators to level the playing field of electronic trading in general.

Real-time policing for potential malfeasance is the most efficient way to regulate high-frequency trading. Analysis of real-time data would provide for effective regulation of these trades. This in turn would provide peace of mind for market participants big and small.

Having spoken with professionals in the world’s most important financial centers, I can attest that America’s capital markets continue being the envy of the world, thanks to the innovation people like high-frequency traders, educated in the country’s top schools, bring to the markets. Let’s allow innovations like high-frequency trading to continue and regulators to police them accordingly, and not try to ban them, as vocal activists tried once with major innovations such as automobiles and derivatives.

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The Fiscal Cliff Debacle: American Exceptionalism Under Attack

Posted on January 2, 2013. Filed under: Debt Ceiling, Economy, Financial Crisis, Fiscal Cliff | Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , |

Madeleine Albright, Edgar Perez and Condoleezza Rice at CME Group's Global Financial Leadership Conference 2012

Edgar Perez with Madeleine Albright and Condoleezza Rice, former U.S. Secretaries of State for Presidents Clinton and Bush, respectively

Last night, the U.S. House of Representatives approved a bill undoing tax increases for more than 99% of households, providing a temporary victory to President Obama and Democrats as Republicans vowed to fight them in the upcoming months for spending cuts in exchange for raising the debt ceiling. The 257-167 vote just before midnight topped a drama-filled day as Republicans initially balked at a bipartisan Senate measure. Ultimately 151 of 236 Republicans voted no. Obama said he’d sign the bill into law.

The final days of the tension surrounding the fiscal cliff of scheduled tax increases and spending cuts illustrated once again the partisan struggle that has made U.S. budget policy unpredictable and prone to crises as deadlines loom. Obama wielded the leverage he gained in his November 6 re-election, securing most of the tax increases he sought without sacrificing the spending cuts he had offered to Republicans in hopes of a larger deficit-reduction grand bargain.

Republicans immediately turned to their next battle, a bid to use the need to raise the nation’s $16.4 trillion debt ceiling to force Obama to accept cuts in entitlement programs such as Medicare. Congress must act as early as mid-February to prevent a default and the dispute may reprise a similar August 2011 episode that led to a downgrade of the U.S. credit rating.

Is the U.S. able to continue giving lessons in American exceptionalism to a world that still respects and admire its past and present? How to explain to the world that current representatives of the American people are able to drive the country so close to a fiscal cliff, potentially dragging the rest of the world? No doubt the majority of Americans have stared at this show with disbelief and puzzlement. Until not so long ago, Americans believed politicians wouldn’t make things so difficult and would reach instead a measured and timely deal. Things didn’t have to go this far to technically miss the deadline.

The answer can be found inside our legal system through the constitution and its twenty seven amendments. In this particular case, section 4 of the fourteenth amendment to the United States Constitution gives the President unilateral authority to raise or ignore the national debt ceiling, and that if challenged the Supreme Court would likely rule in favor of expanded executive power or dismiss the case altogether for lack of standing, as argued by Jeffrey Rosen, legal affairs editor of The New Republic. Furthermore, the president’s role as the ultimate guardian of the constitutional order, charged with taking care that the laws be faithfully executed, provides him with the authority to raise the debt ceiling, as argued by Eric Posner, professor of law at the University of Chicago, and Adrian Vermeule, professor of law at Harvard University.

After the Great Recession of the 1920s, as President Franklin Roosevelt was moving ahead with his plans to confront the economic crisis, he hinted darkly that “it is to be hoped that the normal balance of executive and legislative authority may be wholly equal, wholly adequate to meet the unprecedented task before us. But it may be that an unprecedented demand and need for undelayed action may call for temporary departure from that normal balance of public procedure.” After this admonition, Congress gave Roosevelt the authorities he sought and he did have to follow through on his threat.

Last night Obama said he won’t “have another debate with this Congress over whether or not they should pay the bills they’ve already racked up.” Let’s just hope that President Obama, a former constitutional law professor himself, has the insight and courage to execute the agenda he was elected for leveraging all the tools provided within our constitutional framework. If he is successful, God bless him. If he fails, the American people will kick his party out of the White House in 2016. There is no excuse for inaction; there is no need for more drama; there is no time for more posturing; ultimately, there is no reason to hold America from displaying the exceptionalism Alexis de Tocqueville recognized centuries ago and the world expects for centuries to come.

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