Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Market panics and bailout manias

People seem to be debating whether it was computers or humans that panicked and caused a temporary intraday drop of almost 10% in the US stock market yesterday. What we do know is that the bailout mania that followed was due entirely to humans. This is what the Nasdaq media release says:

The NASDAQ Stock Market had no technology or system issues associated with the trading that occurred between 2:00 and 3:00 p.m. ET today. The NASDAQ Stock Market operated continuously and its close process ran successfully.

In addition, there is no indication at this time that a NASDAQ market participant experienced a technological failure in connection with this event. NASDAQ has coordinated a process among U.S. Exchanges and therefore, pursuant to rule 11890(b), NASDAQ, on its own motion, will cancel all trades executed between 14:40:00 and 15:00:00 greater than or less than 60% away from the consolidated last print in that security at 14:40:00 or immediately prior. This decision cannot be appealed. NASDAQ has coordinated this decision with all other UTP Exchanges. NASDAQ will be canceling trades on the participant’s behalf.

Make no mistake. This is a bailout as bad and sordid as all the bailouts that we saw in the financial sector in 2008. It is bad because it reduces incentives for the firms to discipline their traders (or redesign their computer algorithms) to reduce the risk of such problems.

Anybody who uses a large market sell order instead of a marketable limit order during a falling market (and that too without looking at the order book) is begging to receive a price of zero for the stock. The market is happy to oblige. These people deserve the price that they got. There is no need for the exchange to ride to their rescue by cancelling their trades.

I wrote a few posts about this kind of thing four years ago:

  • Mizuho’s $335 million trading error: here and here
  • BSE Tulip trading error: here

Why have things not changed? Because, it is so easy to bailout everybody, it is much harder to change things.


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