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The Honolulu Advertiser
Posted on: Saturday, May 8, 2010

Search on for cause of chaotic drop in stocks

By Stevenson Jacobs and Bernard Condon
Associated Press

NEW YORK Regulators and Wall Street officials went through millions of trades one by one yesterday and canceled thousands as they sought to explain a record plunge in the stock market, undo damage and keep it from happening again.

It wasn't clear how long the laborious process would take or if it would even solve the mystery behind Thursday's harrowing trading session that saw the Dow Jones industrial average fall hundreds of points and then recover, all in a matter of minutes. The chaotic slide some stocks briefly fell to near zero brought back memories of the darkest days of the financial crisis.

The Securities and Exchange Commission and the Commodity Futures Trading Commission were investigating but on the day after, there were more questions than answers:

• Did a single trader mistakenly punch in the wrong number of shares when making a sell order, maybe mistyping "billion" instead of "million" and setting off a market-wide panic that at one point pulled the Dow down almost 1,000 points?

• Did high-speed computerized trading systems that are supposed to make markets work smoothly go haywire, sending stocks into a nosedive?

• Most important to anyone with money in the stock market: Could it happen again?

Maybe the scariest part was that no one could unravel what happened. That left executives at the major stock exchanges pointing fingers at each other, and the public wondering if the hidden world of high-frequency, computerized trading that fed the panic posed a threat to their 401(k)s.

"It could be awhile before they figure it out because they have to sift through everything trade by trade," said San Diego State University finance professor Dan Seiver, who has followed the markets for 52 years. "And humans are a lot slower than machines."

Thursday's trading was enough to stir fear among even the most seasoned market veterans.

The Dow had already fallen nearly 400 points by around 2:40 p.m. Yet the damage only got worse. The Dow tumbled 600 points in seven minutes, giving it a record one-day loss of 998.50, or 9.2 percent. Minutes later, the index inexplicably turned up again, erasing most of the losses.

Among the hardest-hit: Procter & Gamble and 3M, whose stocks are among the highest-priced of the 30 stocks in the Dow industrials average.

On Thursday, at 2:42 p.m., P&G was trading at $61.73. Within seven minutes, it fell 36 percent. That drop alone accounted for 169 of the nearly 500 points that the Dow lost during the same time.

Similarly, 3M shares, which fell 17 percent from $83.38, took another 109 points off the Dow.

How did it happen? Speculation on trading floors initially centered on a computerized selloff possibly caused by a typographical error. One theory was that a trader trying to sell millions of shares accidentally sold billions, a move that would have triggered a wave of automatic selling.

The SEC is poring through trading data containing millions of transactions to try to identify what might have caused the disruption, according to two people familiar with the matter.

On Capitol Hill yesterday, Sens. Ted Kaufman, D-Del., and Mark Warner, D-Va., called for the SEC and the Commodity Futures Trading Commission to conduct a thorough study of high-frequency trading and other tools that move markets in milliseconds.

"We saw a living, breathing, real-time example today of the potential catastrophe that takes place if we don't have an ability to make sure we adequately use this technology," Warner said late Thursday.

"Right now, there is no way to know what is happening in this marketplace," Kaufman said.

One theory was that high-frequency traders pulled out of the market completely during the drop, which might have sent the markets even lower because there were only sellers and no buyers.

But Jeff Wecker, chief executive of Lime Brokerage, which caters to more than 100 high-frequency trading firms, said his clients traded more not less during the steepest drop.

"They're the reason the market rebounded as rapidly as it did," he said.