Kevin Drum - May 2010

The Market Tank: Take Two

| Fri May 7, 2010 12:05 PM EDT

Let's try again: what happened to the stock market yesterday? We still don't know, but it appears that something concrete happened against the background of a market that was already tripwire nervous over Greece and the euro and China and whatnot. Over at Kid Dynamite's site, a guy with experience writing computerized trading algorithms offers this suggestion:

Considering that the giant decline happened on pretty much *no* volume, I think other factors are at work. I believe the core problem here was a real order imbalance with lots of volume (which took us down the original 350), then nyse halts these stocks, the market orders get rereouted (regnms and all) to ECN's where there is much less liquidity, and what liquidity is normally there is mostly provided by the nefarious HF strats who were rightly scaling back risk. So the 10K shares that might have been a downtick on nyse blows throught the BATS book completely.

In English, this means that when trading started to get too hot and heavy, the New York Stock Exchange stepped in to slow things down. In the old days, this would have worked, but not anymore. Most trading of NYSE stocks doesn't actually happen on the NYSE anymore, it happens on electronic communication networks (ECNs) like BATS in Kansas City, which is the third-largest stock exchange in the world. So what the algo guy is saying is that when the NYSE tried to slow things down, the computers responsible for program trading just switched their orders over to ECNs. Unfortunately, ECNs are largely used by high-frequency trading shops, and the HFT guys closed up when the market went kablooey. So the ECNs had no buyers, and even a small sell order could blow the doors off a stock price. Which it did.

Quite aside from the merits of the HFT controversy itself, this is symptomatic of an overall problem that we've all become pretty familiar with lately: the people in charge of financial markets don't really know what they're doing anymore. In the derivatives industry, they created securities so complex that no one understood them and no one understood just how interconnected and dangerous they'd become. In the trading industry, a combination of ECN-based dark pools, HFT algorithms, and God knows what else have created a trading environment that no one truly understands and no one can control. Obviously markets can boom and crash just fine without these innovations, but they can sure boom and crash a lot bigger and a lot faster with them. Felix Salmon comments:

There's a very sensible idea going around that a simple way to deal with nearly all of these problems, at a single stroke, would be to implement a tiny tax on financial transactions. Historically, people have complained that such a tax harms liquidity, which is true. But the fact is that it harms the bad kind of liquidity — the liquidity which dries up to zero just when you need it most. Liquidity, if it's spread across multiple electronic exchanges and can disappear in a microsecond, does very little actual good, and in fact does harm during tail events like this. Let's tax it, and raise some money for the public fisc at the same time as slowing down markets and making them think before doing a trade.

I'm very much in favor of this. Maybe someday we'll understand all this stuff well enough to control it, but right now we don't seem to. Our financial system really needs a little bit of sand in the gears to bring it back down to human speeds. This would be a good way to do it, and would probably have other benefits too (quite aside from the money it raises). Count me as a fan.

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Supreme Court Not So Popular These Days

| Fri May 7, 2010 11:09 AM EDT

Greenberg Quinlan Rosner has a new poll out asking people what kind of Supreme Court justice they'd like Obama to nominate. Basically, they seem to want someone who's fair to individuals but not an activist, and independent but supports civil rights. What's more, they oppose the court's decision banning partial birth abortion but don't especially think kindly of judges who support abortion rights. In other words, they really have no clue.

Still, I thought the responses below were sort of interesting. Obviously question wording is everything, so take this with a big shaker of salt, but generally speaking people are not just opposed to the recent Citizens United decision, they're also opposed to a lot of the court's other recent illiberal decisions. I'm not sure what to make of this — if anything — but thought I'd pass it along.

Good Jobs News in April

| Fri May 7, 2010 10:25 AM EDT

I may be generally pessimistic about the economy, but we did get a good jobs report today. It wasn't just census hiring either. It was legitimately strong private sector job growth. The unemployment rate rose at the same time — and as the CBPP chart on the right suggests, this means we're probably in for a long, slow, grueling, recovery — but Eric Lascelles of TD Securities explains why a rising unemployment rate isn't entirely a bad thing:

The household survey argued for an even better 550,000 job gain in April, but the number of people looking for jobs rose by an even larger 805,000. As such, the unemployment rate went up. However, the interpretation can be spun in a positive direction since job applicants must be feeling good to seek entry to the labour force in such large numbers.

Steve Benen's employment chart is below. On the less bright side, long-term unemployment increased and wage growth was flat. The latter is obviously normal during the early stages of a recovery, but still, it needs to change if consumer spending is going to keep fueling growth. Overall, though, the report was good news. I'm still sort of pessimistic, but then again, I'm always sort of pessimistic.

Why Did the Market Tank?

| Fri May 7, 2010 10:00 AM EDT

Hey, remember how one of the big benefits of high-frequency trading is supposed to be that it deepens market liquidity? And remember how I wrote that, in reality, HFT probably does a great job of providing liquidity when you don't need it and a lousy job when you do need it? Well, yesterday the stock market needed liquidity and guess who didn't provide it?

Tradebot Systems Inc., a large high-frequency firm based in Kansas City, Mo., closed down its computer trading systems when the Dow Jones Industrial Average had dropped about 500 points, said Dave Cummings, founder and chairman of the firm....Mr. Cummings said Tradebot's system is designed to stop trading when the market becomes too volatile, too fast.

....The withdrawal of high-frequency firms from the market didn't necessarily cause the downturn, but could have added to it, some market experts say. A number of high-frequency firms closing down in the midst of a sharp market drop can "widen markets out substantially," said Jamie Selway, managing director of New York broker White Cap Trading.

In other news, the SEC is investigating what happened yesterday: "U.S. regulators plan to examine whether securities professionals triggered yesterday’s stock-market plunge or exploited the turmoil to profit illegally, two people with direct knowledge of the matter said....The SEC and Commodity Futures Trading Commission said in a joint statement after U.S. markets closed that they will examine 'unusual trading' that contributed to the plunge."

Overall, I'm with Atrios. Maybe this whole thing was mostly a glitch, maybe not. "Still, my gut tells me we are heading in a downward direction." Maybe not today and maybe not next week. But the aftermaths of banking crises don't usually play out in just a year or two. Normally it takes three or four. We're still in the middle of the hurricane.

Chart of the Century: Cooking The Planet

| Fri May 7, 2010 12:15 AM EDT

What happens if we do nothing about greenhouse gas emissions and end up in a worst case climate change scenario a century from now?  A new paper in the Proceedings of the National Academy of Sciences takes a look at the likely effects of very high global warming and concludes that large swathes of the world — including the East Coast of the United States — would become pretty much uninhabitable. In the map below, that's all the yellow and light purple areas.

Stuart Staniford has the details. But don't worry. It's only 5% likely that things will ever get this bad. Or the scientists might have miscalculated. It might only be 1% likely. Those are pretty good odds, right?

The Copenhagen Tapes

| Fri May 7, 2010 12:04 AM EDT

Remember that accidental tape recording of the final session of the Copenhagen summit that I wrote about a few days ago? Well, Der Spiegel now has the entire thing translated into English. In their telling, at least, pretty much no one comes out of this looking good.

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Can Congress Strip Your Citizenship?

| Thu May 6, 2010 11:41 PM EDT

Joe Lieberman wants Congress to pass a law that would allow the State Department to revoke American citizenship from people suspected of allying themselves with terrorists. Now, the prospects for abuse here are pretty obvious. But set that aside for a moment. Even if it were a good idea, would it actually accomplish anything? Or is it mostly just anti-terror showboating?

According to citizenship law expert Peter Spiro, it's pretty much the latter. No matter what Congress says, the Supreme Court long ago ruled that citizenship can only be stripped from a person who performs an act with the specific intent of relinquishing citizenship:

Intent to relinquish would be pretty hard to establish, Shahzad’s case included....That’s the first way in which [the proposed law] would be ineffective: you just end up with another layer of litigation, about the last thing that anti-terror policies need after almost a decade of up-the-courts, down-the-courts delay.

And all for what, exactly? Citizenship makes a difference only with respect to a small slice of one anti-terror policies. By statute, the use of military commissions can only be used in the prosecution of noncitizens. Under Verdugo, nonresident noncitizens don’t enjoy Fourth Amendment protections. But remember what citizenship doesn’t protect you against: even Obama has authorized the targeted killing of citizens abroad, and Hamdi doesn’t mandate full due process for citizen detainees.

Lieberman and cosponsors try to frame this as a matter of prevention, depriving terrorists of the valuable tool of a US passport. This is nonsense. Anyone visibly affiliated with a terror group is already going to be on all sorts of no-fly and surveillance lists before that affiliation would warrant proceeding with expatriation. A passport isn’t much of a weapon then.

It's true that if Congress changes the law, this might open the door for the Supreme Court to reverse its earlier rulings on this subject. But even in the unlikely event that it did, the effect of the law would be minimal. And the potential for political abuse would obviously remain. So yeah: it's mostly just anti-terror showboating. Not exactly a big surprise coming from Joe Lieberman. (Via Kenneth Anderson.)

Arabic on the Net

| Thu May 6, 2010 11:16 PM EDT

Just so you know: according to ICANN, today was "the most significant day" since the launch of the internet. Why? Because for the first time ever, you can type in a full URL, including the top level domain name, in a non-Latin alphabet. Namely, Arabic:

One of the first websites with a full Arabic address is the Egyptian Ministry of Communications. Egypt's communication and information technology minister Tarek Kamal told the Associated Press that three Egyptian companies were the first to receive registrar licences for the '.masr' domain, written in Arabic.

Other countries will get top level domains in Arabic shortly, and further non-Latin alphabets are in the works. So now you know.

Our Lucky Ozone Escape

| Thu May 6, 2010 7:45 PM EDT

You all know the story of Stanislav Petrov, right? He's the Soviet lieutenant colonel who was on duty in 1983 when an early warning system reported that an American ICBM was heading toward the Soviet Union. Luckily (and correctly), he decided it was just a computer error and decided not to start World War III. Whew!

That's about how I felt when I read Brad Plumer's piece on possible planetary disasters in the last issue of the New Republic. I'd never heard this story before, but it turns out that back in the middle years of the 20th century Planet Earth dodged a serious ozone layer bullet thanks to nothing more than a chance decision1 by Dupont about how to manufacture chlorofluorocarbons:

As luck would have it, DuPont had been using chlorine instead of bromine to produce CFCs. As far as anyone could tell, the two elements were interchangeable. But, as another prescient ozone researcher, Paul Crutzen, later noted, bromine is 45 times as effective at destroying ozone as chlorine. Had DuPont chosen to use bromine, the ozone hole could well have spanned the globe by the 1970s instead of being largely confined to Antarctica — long before anyone had a glimmering of the problem.

It’s not hard to see what massive worldwide ozone depletion would’ve meant. Punta Arenas, the southernmost town of Chile, sits under the Antarctic ozone hole, and skin cancer rates there have soared by 66 percent since 1994. If humans had destroyed stratospheric ozone across the globe, we would likely be unable to set foot outdoors without layers of sunscreen and dark shades to prevent eye damage. Worse, the excess UV rays could have killed off many of the single-celled organisms that form the basis for the ocean’s food chain and disrupted global agriculture (studies show that bean and pea crop yields decline about 1 percent for every percent increase in UV exposure).

Just thought I'd share. Let's be careful out there, OK?

1In comments, Daryl Cobranchi points out that the reason Dupont used chlorine is that it's less expensive than bromine. So the "luck" here isn't that Dupont tossed a coin and it came up on the right side, it's the fact that Cl2 happens to be cheaper than Br2.

Did a B Kill Wall Street?

| Thu May 6, 2010 4:37 PM EDT

The stock market plummeted today, but it did so in an odd way: the Dow dropped about 6% in the space of five minutes and then gained about 5% a few minutes later. Initial news reports suggested the drop was centered on panic over Greece, but there was no special news about Greece that suddenly hit the wires at 2:30 pm and then, just as suddenly, disappeared a few minutes later. Perhaps, instead, it was just a garden variety screwup?

The WSJ reports that a trader may have accidentally placed an order to sell $16 billion in futures tied to stock indexes, when he meant to place the order for $16 million.

And there were "a number of erroneous trades" during the minutes when the market was plunging, a spokesman for the company that owns the New York Stock Exchange told Bloomberg.

The FT's Alphaville blog points out that Procter & Gamble shares fell by more than 20 percent — about three times as much as the Dow — before regaining almost all of the ground it lost, and says the decline may have been related to a "technical screw up." And Barron's notes that shares in Accenture — which opened and closed the day above $41 per share — traded for one cent per share at one point today.

Planet Money's chart of the Procter & Gamble drop is above (P&G = blue, overall market = red). So I wonder whose screwup this was? Rumors suggest it was some poor schlub at Citigroup. And what happened to all those automated systems we hear so much about that are supposed to prevent this kind of thing? After the Société Générale debacle didn't everyone supposedly install safeguards that prevented individual traders from taking massive positions like this?