The 2010 Flash Crash
The New York Stock Exchange was born on March 8, 1817 on Wall Street, New York City, New York. The marketplace has become synonymous with the glamorous lifestyle of investors, bankers, and any career within the financial services sector due to the lucrative nature of the industry. Many famous investors have rose to fame and are regarded as genius’s from their success on the streets of Wall Street, but many have also went down in notoriety and failure. As with most markets, the stock market has had many highs throughout history, but at the risk of many downturns in the market, some of which had threatened the United States as a country. Throughout its existence, the stock market has experienced five major crashes that molded the financial sector of the United States into what we see today. In this paper, I will be talking about the 2010 Flash Crash, a market crash I personally had little knowledge prior, even though it occurred during the later stages of my lifetime.
The story of the Flash Crash begins in Greece, where the text begins by with an anecdote of how the death of an innocent pregnant woman waiting for her husband is unfortunately killed during riots. Nation describes how Greece has struggled over time both economically and politically, such as the countries’ use of creative accounting to make the countries financial statements more appealing internationally and domestically. Furthermore, the creation of the European Union was formed only pressured Greece to seek entrance into the exclusive union by any means possible, regardless of their issues with GDP, long-term debt, interest payments, and essentially negative cash flow balance as a country. Until Greece met the parameters of the union, it was not allowed to join. Ultimately, the country was able to become a member if it followed the conditions it was put under, but at the cost of future leaders and citizens who later uncovered the fraud was much more critical than estimated. Eventually, Greece was forced to deal head on with the problems they were concealing, which ultimately lead to a paralyzed country begging for the assistance from fellow European Union nations.
Externally, the issue of Greece possibly falling and ultimately being unable to pay their debt back to other countries was the main issue for countries around the world. For example, a financially stronger Germany would have ultimately been affected if Greece fell because it would eventually result in countries unable to pay back their debt to the country, even though Greece had about 8% of the financial strength within the group. Furthermore, many international markets would be hurt if Greece were to go bankrupt as a country because individual countries most often owned or owed debt to another. Unwillingly, the vote in favor of aiding Greece ultimately decided for Germany and other countries involved.
In relationship to the actual Flash Crash in the United States, the ultimate cause occurred as a result of computer algorithms completing trades in reaction to the economic issues in Greece. The firm of Waddell and Reed was one of the specific causes, as their algorithm was used to sell a mass volume of the future contracts without entering any information on pricing. The reason for them wanting to sell so many contracts was partially due to fear, uncertainty, and doubt in connection to Greece’s failure. They feared that the future contracts, which consisted of a large portion of their portfolios, would soon decline in value when negative news of Greece was expected the next day. As a result, the algorithm proceeded to sell these contracts throughout the day, which tested the available liquidity in the market to its limits. When other investors decided to stop buying and selling their contracts, the selling continued which eventually led to millions of contracts being traded at a enormous rate below the average closing values. The market had to be manually stopped to allow for adjustments because the algorithms assuming liquidity when there was in fact very little anymore in the market. Ultimately, the price of the future contract dropped to over 80% below the normal market value before rising back up in value the same day.
Hence, the Flash Crash of 2010 was the latest of stock market crashes experienced by the New York Stock Exchanged that has changed the way the financial sector is regulated. Additionally, these market crashes, including the Flash Crash, all have not occurred from single factors in the environment or one individual. Rather, Scott Nations states in the book A History of the United States in Five Crashes
“Every modern stock market crash has an external catalyst at its heart. These external catalysts – some are acts of nature, such as 1906’s earthquake; some are geopolitical, as in 1987 and 2010; some are political, as in 2008; and some are criminal, as in 1929 – are not sufficient themselves to start a crash, though they are necessary (18).”
In essence, Nations argues that it is a confluence of factors, external, economic, political and even psychological, that result in these major market crashes. With this in mind, I believe the takeaway message from Nation’s text is to recognize the multitudes of factors, both internal and external, that affect the financial market. Although the stock market has always recovered over time, it is still important to recognize conditions presently that may have the potential to lead to meltdowns. Ironically, my last internship at Morgan Stanley was where the idea of the economy being affected by multiple factors was engrained in my brain from my senior manager, but I digress. In the end, it is not about the market crashes that have happened in the past, but being able recognize factors presently that can converge and result in the next crash.