What The Hell Happened?

It’s been over 24 hours now and still no one has any idea as to what caused Thursday’s bogus market plunge. Needless to say, that’s not good.

Yesterday’s market swerve: fat fingers, glitch, or cyber-warfare?

Theories about yesterday’s stock market swoon, where within a matter of 20 minutes, the stock market plunged by 1,000 points and then nearly completely recovered, are abounding. Fortune asked Rishi Narang, founder of the hedge fund Telesis Capital and author of Inside the Black Box, to share the theories he’s heard and handicap them in terms of likelihood and plausibility.

Narang, who uses high-frequency trading techniques, explains why high-frequency traders got out of the market during the dive, and why the catalyst for the drop is far more important to understand than the drop itself:

What happened yesterday?

There are two points to understand. First, what catalyzed the activity? What was the reason for the market wanting to fall? It might be that the catalyst was of such size that it overwhelmed all other factors. There are three plausible theories:

1) The fat finger. Plausible, but unlikely. Typing in billions with a “b” versus millions with an “m” seems impossible. Trading systems don’t work that way. More likely, the trading system accepts the sell/buy amount in thousands. Some trader in the heat of the moment forgets it’s in thousands, types in an order for 16,000,000 instead of 16,000. That kind of thing seems far more plausible.

But even then: why on Earth would the trading entry system not have a sanity check? For almost no one in the world is a $16 billion sell order okay to send out as soon as it’s entered. The trader should be fired, along with everyone in the IT department. If this happened, most likely, it was something along those lines. If it wasn’t all one order, maybe it was meant to sell just $1 billion shares but was sent 3 or 5 times instead of once.

2) Software error. Plausible, likely, but doesn’t fit the facts. Here, the trading software is in a recursive loop, pounding out sell orders due to a bug somewhere in the software. In a sense, this is more plausible, more likely, but doesn’t seem to fit the facts well enough.

The speed of the decline in the market just doesn’t seem to fit — should be a series of small orders, not a series of large orders. In 7 minutes we saw a 580-point drop. That doesn’t look like a recursive loop. But there is a lot of software, and somewhere a bug is bound to exist. You can easily imagine a software glitch happening. Things go buggy. Like the Toyota [accelerator] problem, at heart a software problem. Technology is a two-edged sword, and this is the other edge of the sword. We rely on software, but it’s not always written well enough.

3) Computer hacking. Implausible without proof, but possible. This is the most interesting theory because we know terrorists are interested in cyberterrorism. We know they would target the financial markets. We know a great day to launch an attack would be one with a mild bit of panic [due to the Greek crisis and sovereign debt downgrades].

Some other really crazy things happened with stocks, like Accenture and Exelon. [Both stocks traded for one cent for short periods of time.] Two parties really transacted on these trades [at one cent], even though they were later busted and cancelled. If it was just high-frequency traders bailing out, why wouldn’t [that drop] happen on every stock? It just doesn’t add up. Things are too idiosyncratic and that feels uncomfortable. This also happened in the options markets, but again, only on a handful of options.

And the second point to understand?

That’s the question of the enabler. What, if anything perpetuated the selloff? And did so in seconds? There’s a lot of speculation about high-frequency traders vanishing from the marketplace.

The consensus is that high-frequency guys didn’t provide the liquidity and that’s what allowed for prices like one penny on Accenture. I do know for sure that high-frequency traders backed off, but old school market makers would’ve done the same thing, in a little bit different way. They just would’ve created super-wide market spreads. Same thing.

We shouldn’t be so sanguine about taxes and impediments to high-frequency trading if we are upset when high-frequency traders leave the market. Those are incompatible ideas.

As a side point: traders have stop loss levels; one big move triggers other moves. There are systematic, discretionary, and plain-old panic trades.

But for all of those styles and programs, once they see the stock market fall 6%, a liquidation effect takes hold. That’s just a function of people. Someone screams fire, and if enough people start running, everyone will. Those are the dynamics of computer software, people, animals, fires, whatever. It’s how we work. That kind of stampeding effect could easily be part of the response.

But the speed of the market falling down, going back up, and partway back down again? If this was really a stampede, why not repeat the 1987 crash [which kept going]? Nothing ‘stopped’ this crash except that the catalyst seemed to have ended.

If it was an error or a software bug, it stopped. If it was a hack, the hackers left. In other words, the enabling side of this drop is totally irrelevant [to the catalyst]. The only interesting thing here is the catalyst. If this was a gas pedal that was stuck, it would’ve looked differently, kept going.

Whether this was intentional or unintentional, it happened all at once. If it was an intentional [attack], then the question is, was it a demonstration, a test, or the attack itself? Whatever it was, we didn’t stop it. It stopped itself.

See also:
Regulators Are Stumped by Drop
NYSE, Nasdaq bicker over stock-market drop
Plunge highlights fragmented markets, fast traders
Stock Market Crash? Or Trading Error?
Theories abound about how the 1,000 point Dow drop occurred
UPDATE: Everyone Seeks Answers Behind Stock Market’s Rout
Programs, NYSE Circuit Breakers Contribute To Market Plunge
Nasdaq cancels the trade of 296 stocks after Thursday’s Wall Street stock market crash
SEC reviewing Thursday’s sudden stock market drop
SEC Said to Outline Possible Causes of Market Plunge (Update1)
House panel to hold stock market inquiry

All I can say is that the investigators at the SEC had better get off their asses, take a break from their prodigious porn surfing, and get to the bottom of what exactly caused Thursday’s bogus market plunge. And they had better come up with a definitive answer quickly.

/the ongoing inability of exchange operators and regulators to pinpoint the problem is beginning to shake market confidence even more than the bogus plunge itself

Smell The Arrogance

Can you just imagine what would have happened if George Bush had said this?

Obama Tells Economic Critics to ‘Get Out of the Way’

A fired up President Obama said Thursday that he wants his critics to just “get out of the way” so his administration can clean up the economic “mess” that Republicans left for him.

Obama spoke Thursday night at a rally in Virginia for state Sen. Creigh Deeds, the Democratic candidate for governor.

He used the bulk of his pep talk to dress down critics who say his economic stimulus is not working and who complain about his administration’s spending. Obama noted that he was handed a deficit topping $1 trillion when he walked into office, and urged the “naysayers” to step aside.

“We’ve got some work to do. I don’t mind, by the way, being responsible. I expect to be held responsible for these issues because I’m the president,” Obama said. “But I don’t want the folks that created the mess — I don’t want the folks who created the mess to do a lot of talking. I want them just to get out of the way so we can clean up the mess.

“I don’t mind cleaning up after them, but don’t do a lot of talking,” Obama said.

See also:
Obama Rallies Deeds Supporters Amidst Tumbling Poll Numbers
At Deeds Rally, Obama Knocks GOP Critics
In Virginia, Obama says US needs pragmatic leaders
Barack Obama wants you to get out of the way
Get out of the way Obama orders

What a pompous, self-righteous, sanctimonious, vainglorious little prick. Look out Moneychangers! Here comes Lord Obama from on high to cleanse the temple! Shut up you evil Republicans, the financial crisis was all your fault and now only Obamanomics can repair all the damage you’ve done and save the country. We won!

Nevermind the extensive role of Barney Frank, Chris Dodd, and the rest of the Democrats had in creating the global financial meltdown, by pushing relaxed lending standards through Fannie Mae and Freddie Mac, covering up problems at Fannie Mae and Freddie Mac, and resisting Rebublican calls for regulation.

The “stimulus” is working, really? Hardly any of it has even been spent! The economy is starting to recover on it’s own, in spite of the “stimulus”. In fact, once all the back loaded “stimulus” does hit the economy, it’ll do nothing except crowd out private sector investment, retard GDP growth, and spur inflation. Obama inherited a huge deficit? Sure, and then he immediately proceeded to triple it in six months. The markets don’t like it and wonder aloud, who the [expletive deleted] is going to end up paying for all this out of control Obama deficit spending?

Frankly, it’s exceedingly obvious that global capital markets are frightened by Obama economic policies and what he might possibly do next. Not one Obama economic policy introduced so far has been business friendly (you know, the people who actually create jobs) or pro economic growth.

If anyone should shut up and get out of the way it’s Obama. He has no earthly idea what he’s doing and his policies are an obvious drag on the economy. If he would just do nothing, the markets would be trading much higher than they are now and the economy would already be recovering at a much faster pace.

/you know, half of America didn’t vote for this hopey changey, sweet smelling unicorn farts bull[expletive deleted]

Unfair Advantage

This shouldn’t be allowed, period.

SEC Probes Flash Orders to Ensure Fair Access to Data (Update3)

The U.S. Securities and Exchange Commission is examining so-called flash orders to ensure equity markets aren’t putting investors at a disadvantage by giving some brokerages advance knowledge about trades.

“The SEC staff is specifically examining flash orders to ensure best execution and fair access to information for all investors,” John Nester, a spokesman for the regulator, said today.

Charles Schumer, the third-ranking Democrat in the U.S. Senate, told the SEC to review flash orders in a July 24 letter. Nasdaq OMX Group Inc., Bats Global Markets, Direct Edge Holdings LLC and the CBOE Stock Exchange give information to their clients about orders for a fraction of a second before the trades are routed to rival platforms. The systems are meant to give investors an additional opportunity to complete a trade.

Last month, SEC Chairman Mary Schapiro said the agency is concerned that electronic indications of bids and offers are being disseminated to a select group of brokerages. She also said it would examine dark pools, private electronic markets operated by brokerages that don’t publicly post quotes.

The review appears unlikely to lead the SEC to impose curbs on other forms of high-speed trading, NYSE Euronext Chief Executive Officer Duncan Niederauer said today, citing discussions with regulators. NYSE Euronext, the world’s largest owner of stock exchanges, told the SEC in May that flash orders result in most investors getting worse prices.

No Fear

“I don’t think there is any fear of them doing something that would severely damage the displayed liquidity on U.S. equity markets,” he said today in a conference call with analysts to discuss the New York-based company’s second-quarter results. “High-frequency trading is actually the most consistent source of liquidity.”

NYSE is building facilities in Mahwah, New Jersey, and near London to boost its capacity to handle high-speed trades. The company is spending about $500 million, the Wall Street Journal reported today, citing people familiar with the matter.

Analysts including Raymond James Financial Inc.’s Patrick O’Shaughnessy said this week that regulators’ response to flash orders might result in restrictions on computer-driven trading, which could hurt profit for exchanges.

Bats, Nasdaq Support

Bats CEO Joe Ratterman said today in an e-mail to clients that the Kansas City, Missouri-based exchange would support an industrywide ban on flash orders. Nasdaq CEO Robert Greifeld told Schumer July 28 that his company would also support a prohibition, according to a statement issued by the New York senator’s office.

Both introduced the systems over the past three months to compete against Direct Edge, the trading platform that has gained market share through its three-year-old Enhanced Liquidity Provider program.

Direct Edge, which is not a registered SEC exchange, more than doubled its market share since November to 11.9 percent of the total volume in the U.S. in June by using revenue from its ELP program to cut other trading fees. The ELP program accounted for 8 percent of the shares handled by Direct Edge.

“If regulators get rid of it, or do anything to significantly circumscribe the program, it will hurt Direct Edge and help Nasdaq and NYSE,” Justin Schack, vice president of market structure analysis at New York-based Rosenblatt Securities Inc., said in an interview. “It takes away a big competitive weapon that Direct Edge used to gain market share.”

Wall Street and the World of Flash Stock Trades

High Frequency Trading

The computers have become traders in just the last few years, say market people. One particularly visible part of what they do is called High Frequency Trading, in which machines, programmed to look for market trends, may buy or sell a stock in milliseconds.

A subset of this phenomenon is known as “flash trading,” in which stock exchanges let firms place super-fast orders to buy or sell stocks — often based on information they receive a fraction of a second before the rest of the world does. Large firms pay fees for the advance information, and may be able to profit by moving so quickly.

See also:
ICE says it doesn’t allow ‘flash’ trading
Nasdaq backs ban on “flash” trading: Schumer
High-Frequency Trading Faces Challenge From Schumer (Update1)
Schumer wants to ban flash trading
SEC Examines ‘Flash’ Trading
BATS CEO Ratterman supports ban on flashed orders
BATS Exchange Supports Ban On ‘Flash’ Orders – CEO

And people wonder why the average investor distrusts Wall street.

/apparently all trades are equal, but some trades are more equal than others

GM Goes Bankrupt, Sun Rises In East, Sky Doesn’t Fall

As widely predicted and telegraphed, the once unthinkable finally became reality today.

GM Files Bankruptcy to Spin Off More Competitive Firm

General Motors Corp., the largest manufacturer to go bankrupt, filed for court protection with a government-financed plan intended to create a viable company that can compete in world markets.

The U.S. government will extend $50 billion of loans to the 100-year-old automaker and plans to convert that into a 60 percent stake in the reorganized company, according to a filing in U.S. Bankruptcy Court in New York. GM today missed a deadline to show that it could reorganize outside of court and reported debt of $172.8 billion, more than twice its assets.

“GM and its stakeholders have produced a viable, achievable plan that will give this iconic American company a chance to rise again,” U.S. President Barack Obama said today. The government was becoming a “reluctant” owner of the automaker, Obama said, adding that his goal was to “take a hands-off approach and get out quickly.”

GM, the largest carmaker until its 77-year reign ended last year, surpassed Chrysler LLC as the largest manufacturer to file for bankruptcy. Detroit-based GM plans to launch a new company in 60 to 90 days, armed with vehicles from its Cadillac, Chevrolet, Buick and GMC units for the U.S. market. The court will supervise the sale or liquidation of unprofitable brands, such as Saturn and Hummer, and at least 11 unwanted factories.

Interim Loan

The automaker won approval of a plan to auction its assets and interim approval of a $15 billion loan from the U.S. and Canada to keep the company going until it can complete the sale, which it plans to do in July.

GM said it has more than 100,000 creditors, and that unsecured creditors will recover some assets in the reorganization. Company operations outside the U.S. weren’t included in the petition.

The case was assigned to U.S. Bankruptcy Judge Robert Gerber in Manhattan, who also presides over the bankruptcies of Lyondell Chemical Co. and BearingPoint Inc. He presided over the bankruptcy of Adelphia Communications Corp. as well.

“Today marks a defining moment in the reinvention of GM,” said company President and Chief Executive Officer Fritz Henderson. “The economic crisis has caused enormous disruption in the auto industry.”

GM listed in its petition as top creditors Wilmington Trust Co., representing bondholders owed $22.8 billion; International Union, the United Automobile, Aerospace and Agricultural Implement Workers of America, owed $20.6 billion; and Deutsche Bank AG, representing bondholders owed $4.44 billion. The Unofficial GM Dealers Committee, which said it represents more than 6,000 GM dealers in the U.S., filed a notice that it will take part in the bankruptcy litigation.

A Matter Of Law

Economy: With General Motors’ long-awaited “pre-packaged bankruptcy” finally here, America is on the verge of a new era — one where government, not investors and consumers, is the final arbiter of success.

GM’s bankruptcy pushes bondholders aside in favor of the U.S. government and the UAW. Though bondholders hold $27 billion in debt, they’ll get just 10% of stock.

How’s that compare with the other “stakeholders?” For spending $50 billion to bail out GM, the government will get 60% of the equity in the new GM; the UAW, which along with other unions gave millions to Democrats, will be repaid for its loyalty with 17.5% of the stock for $10 billion of unsecured debts.

So the government, with roughly two times what private bondholders have on the table, gets a stake five times bigger. And the union, with about a third as much “invested,” gets a 70% bigger stake. Even the Canadian government, with its $9.5 billion “invested,” ends up with 12%.

They call it “restructuring.” We call it theft. Never in our memory has there been a more thorough, systematic effort to disenfranchise the shareholders and bondholders of a major American firm.

It will make investors — domestic and foreign alike — think twice about investing in an American stock or bond in the coming years. Why invest if your money and rights as an investor can be arbitrarily stripped from you, as they were in GM’s case?

But our real issue with this isn’t that people will lose money. It’s that we don’t believe the government’s actions are even legal.

The White House has basically been manipulating GM into bankruptcy since early this year, putting 31-year-old Brian Deese, a Yale law student, in charge of GM’s restructuring. “It is not every 31-year-old who, in a first government job, finds himself dismantling General Motors and rewriting the rules of American capitalism,” the New York Times said with tongue in cheek (we think).

It used to be that the “rules of American capitalism” came from 200 years of U.S. case law, the Constitution and legitimate federal regulation. But no more. Instead, the job’s been given to someone not yet out of law school. This shows shocking contempt for GM, once the world’s pre-eminent industrial company, for American capitalism and the rule of law.

We don’t think this travesty passes constitutional muster and hope to see it vigorously challenged in federal court soon.

Our Constitution is very specific. It limits the executive branch’s rights to those enumerated therein. The rest it grants to the people and the states. It also requires due process under the law, especially when government “takings” are involved.

That’s why in 1952, when President Harry S. Truman tried to seize control of the U.S. steel industry during a debilitating strike, the Supreme Court made him back down. And Truman had a real emergency on his hands: the Korean War.

We pored over Article II of the Constitution, known as the Executive Powers Clause. Nowhere is the White House granted the right to override the time-tested bankruptcy process, to use Treasury money raised by taxing Americans to buy or bail out companies, to fire CEOs, to micromanage corporate policy, or to abrogate lawful contracts made by private parties.

Yet, our government has done these things and more — leading to a corrupt GM bankruptcy. The damage to our system of corporate capitalism and the rule of law is severe. Next stop: Federal court?

See also:
GM Collapses Into Government’s Arms
General Motors files for bankruptcy
GM declares chapter 11 bankruptcy
World’s Largest Company Files For Bankruptcy Protection As GM Makes It Official
General Motors may follow Chrysler’s path to quick exit from bankruptcy

So, this travesty of a probably illegal boondoggle taxpayer funded GM bankruptcy, alarmingly prophesied as the loosing of the seventh seal of the Apocalypse, was filed in U.S. Bankruptcy Court in New York today. What were the dire and scary consequences? Did the economy fall off a cliff into the abyss? Was there panic in the streets? Did dogs and cats start living together, was there mass hysteria?

Hell no! Wall Street and the equities markets not only totally ignored the GM bankruptcy, all the major stock market indices soared, tacking on gains of 2 1/2-3% each, having their best session in months! Personally, I had a great day!

/so, once again, all the Chicken Littles were wrong, GM should have been put into bankruptcy six months ago, it would have saved the taxpayers $20 billion that has all since been flushed down the GM/UAW toilet, never to be seen again

Best Trade of The Year, So Far

Okay, so a week ago today I started doing my homework. I read Monday’s IBD and went to work compiling my primary watch list. Out of 19 stocks, only two were close to buy range, and I only liked one, GMCR. One problem, it was trading around $52, still $3 below it’s proper technical buy point. So I set a stop limit order, $55.71 stop, $55.75 limit. I ended up with a good boatload of the stock at $55.75 on Tuesday.

It pulled back precipitously during market hours Wednesday and then, after reporting earnings, Green Mountain Coffee Roasters exploded after hours. The stock opened at ~72 Thursday, peaked at $79. I sold it at $75. Do the math.

/I don’t need to work for a few months, but I’ll be back at it Monday