Who’s the culprit in Wall St. crash?

Opinion: October 21, 2010 at 12:00a.m.

By Bart Chilton

McClatchy-Tribune

On May 6, U.S. financial markets became unhinged for 20 minutes. In that time, many lost significant investments. Stock in Accenture, for example, went from $40.13 to just a penny before recovering. The stock market lost nearly 1,000 points, then recovered most of it by the close of trading. If the crash had occurred earlier that day, when European markets were open, it would have rocked the entire financial world.

Now, after months of investigation, a government report tells us what happened. Unlike a satisfying “whodunit” mystery, the document doesn’t point fingers at a single culprit. It describes markets that were skittish due to worsening economic news from Europe. Volatility was double normal levels. Sellers were having difficulty finding buyers. Then it happened: one firm used a robotic trading program to sell 75,000 contracts valued at more than $4 billion. That was enough to send markets into cardiac arrest.

Buy low

Arbitrageurs, seeing one market plummet, recognized an opportunity to buy low at one exchange and sell corresponding contracts at a higher price elsewhere. Within minutes, a domino decline ensued as most markets plunged. Traders got scared, and wicked widespread disruption began.

So who is the Flash Crash culprit? It appears it is the financial markets themselves. We’ve seen the enemy, and it is us. Markets today, after a decade of deregulation, operating under the free-wheeling “greed is good” mantra, with vast interconnectedness and with lightening-speed trading couldn’t take it. The system simply failed.

The good news is that markets were resilient, recovering much of the loss. It’s also good news that regulators and exchanges are instituting procedures to make markets more effective and less susceptible to disruption. But Band-Aid fixes won’t solve this problem.

Importantly, the new Wall Street Reform Act is a structural game-changer for these markets. There will be more transparency and oversight, limits on speculation, double and triple backstops that can help avoid another meltdown. With this new oversight, we can say with much greater confidence that if a similar situation happens again we will be able to address it and swiftly identify the culprits.

No money

But not so fast: Congress gave regulators the responsibility to implement the law, but guess what? There may not be funds to do the job, to have the people power and the computer capability to institute the changes Congress itself sought. It would be nice, after getting the definitive word on the Flash Crash, to know we are going forward with confidence and clarity to ensure markets are sound and that our 401(k)s are safe. Only if Congress approves funding to implement these changes are we able to do that. Let’s hope that happens. Otherwise, we better keep the first-aid kit nearby.

Bart Chilton is a commissioner on the Commodity Futures Trade Commission, Washington, D.C.