Rod Dreher

Lolo Jones: Smells Like Tebow Spirit

The Tech Monster That Ate Wall Street

By Rod Dreher • August 6, 2012, 2:30 PM

Last week, Knight Capital, a multibillion trading company that was one of the pillars of Wall Street, was very nearly destroyed in a single day by a computer glitch. The Wall Street Journal reported:

Knight, a 17-year-old firm, is considered a pillar of the stock market, matching buyers and sellers for some $20 billion in trades a day on the New York Stock Exchange. Knight uses complex computer algorithms to trade swiftly in and out of stocks while retail brokerages rely on the company to execute billions of dollars of trades a year for small retail customers. The firm is also one of the biggest firms to handle trading in exchange-traded funds. While it has humans on hand to do some trading, much of its business is now computerized.

The loss exceeded Knight’s $365 million cash on hand at the end of the second quarter. Most of the trades were made Wednesday between 9:30 a.m. and 10:15 a.m. That would equate to about $10 million a minute.

The computer program that caused the glitch was designed to integrate with a new system being installed Wednesday morning by the New York Stock Exchange, Knight Chief Executive Thomas Joyce said on Bloomberg television on Thursday.

But an error in the Knight software caused a malfunction. By the time engineers could switch it off, millions of trades had gone through.

Think about that: the company was nearly destroyed in about 45 minutes, by a software glitch. Henry Blodget is worried:

So, what does all this mean? Will Wall Street and regulators finally wake up to how much the world has changed in the past decade–and do something about it?

Unlikely, says Scott Patterson, a Wall Street Journal reporter and the author of DARK POOLS: High-Speed Traders, A.I. Bandits and the Threat to the Global Financial System.

The Knight Capital disaster, along with the many technical problems that have preceded it, should be taken as a sign of how much unseen technology risk has entered the financial system in recent years, Patterson says. Computer trading systems and exchanges have now gotten so complex that the the next Knight Capital may be a “Too Big To Fail” bank, which wakes up to find that a similar “glitch” has blown a multi-billion-dollar hole in its balance sheet. Unlike Knight Capital, that glitch will necessitate another taxpayer bailout and further undermine confidence in the global market system.

Regulators and Wall Street should be terrified by what happened to Knight, Patterson says. But, most likely, as with other warning signs, this latest technology problem will just lead to discussions that will then go nowhere.

To think that a pillar of Wall Street can crumble in less than an hour because of a software glitch is to realize that the financial weapons of mass destruction are very much with us, and threaten us at every moment. Who can stop them? Who will stop them?

Posted in Decline and Fall, Economics. Tagged Knight Capital, software, trading, Wall Street.

12 Responses to The Tech Monster That Ate Wall Street

Linda says:

August 6, 2012 at 3:15 pm

I can say from personal experience that the regulators have no interest in reviewing the controls for electronic trading systems. They only care about making the trading exchanges happy in hopes of going through the revolving door to multiple million dollar salaries. Congress is well aware of the problems. Only a very small number have tried unsuccessfully to make the regulators do their job, such as Bernie Sanders, Maria Cantwell (R-WA), and a Senate Democrat from a NE state that uses “cops on the beat”

Until voters wake up and learn about the complex issues instead of relying on media sound bites, nothing will change.

In addition, whistleblower laws are a joke, including those that are suppose to protect federal employees.
Steve says:

August 6, 2012 at 3:41 pm

If they don’t take down the rest of the system, and only risk their own money, why bother to stop them? As long as we get rid of TooBigToFail, let them do whatever they want. I think it’s more dangerous to believe that government regulators will be smart and savvy enough to make sure all possible financial disasters are regulated away.
Peter B. Nelson says:

August 6, 2012 at 3:46 pm

First off, I’m glad Kight isn’t being bailed out. It seems they tried to get the exchange to cancel all their trades, and the regulators refused. It’s about time.

Second, it should have taken 45 seconds to shut down the errant program, not 45 minutes. Someone isn’t telling the whole truth.

Finally, day trading worked better when real human beings, called “specialists”, ran “the post” on the floor of the New York Stock Exchange. They all cashed out after uper-regulator A.G. Eliot Spitzer hounded out their last supporter, NYSE chairman and CEO Dick Grasso. Grasso was replaced by John Thain from Goldman Sachs who de-mutualized the NYSE (converted it from partnership a to a corporation) and replaced specialists with computerized firms called Designated Market Makers, DMM’s, ala Knight Trading. Not coincidentally, the technology they used was based on ARCA, a firm owned by Goldman Sachs.

There’s a lesson about the evils of converting partnerships into corporations (e.g. small doctor owned clinics morphing into large hospitals) and in the evils of regulators who clear the field only to make room for even worse malefactors.
MH - Secular Misanthropist says:

August 6, 2012 at 3:55 pm

It has been my experience that senior managers do not understand technology and have no desire to. They also fail to appreciate the concept of existential technological risk until after bad events. They quickly forget that pain as they have short memories too.

It’s not just in the software field that has this sort of potential. Humans aren’t wired up to handle the concept of low probability catastrophic risk. Probably because the leveraging effect of industrial technology are a fairly new development in human affairs.

Remember after Katrina when President Bush said, “who could have thought the levees would fail”, only to have engineers tell him they were sounding alarms well before the event?

Where this gets dicey is to project this risk into the future. Eventually humans may develop world ending sorts of technology. Think a matter to energy power plant that has a low probability of creating a black hole.
JonF says:

August 6, 2012 at 6:28 pm

MH
Any black hole we humans could create would dissipate via Hawking radiation in tiny fractions of a second. To get a long-lived black hole you need something really, really big– larger than our sun even.
Peter H says:

August 6, 2012 at 6:44 pm

Shades of the line attributed to Lenin: When it comes time to hang the capitalists, they will sell us the rope.

The updated version might read more like this: When it comes time to commit suicide, the venture capitalists will borrow against the equity in the rope to secure a majority stake in the gallows.
Liam says:

August 6, 2012 at 8:10 pm

As we’ve learned, we’ve traded crude and inefficient but relatively effective regulations (like Glass-Steagall) for more subtle but less effective regulations.

One crude but extremely free-market approach here would be to require that all organizations that are to be licensed to operate markets and exchanges for securities, derivatives and commodities be organized as general partnerships of natural persons exclusively (so that there is no possibility of a corporate shield against personal liability – there is no natural free-market right to such a shield). The insurance and reinsurance markets would have a tremendous incentive to assist in oversight of the activities of the general partners who seeking liability insurance….
MH - Secular Misanthropist says:

August 6, 2012 at 9:01 pm

JonF, probably true, but at the present time Hawking radiation is only hypothesized to exist. Would you bet your planet on that? There’s a good hard science fiction short story called “How we lost the Moon” where the Human species loses that bet on the Moon.

Even without something that exotic, it seems clear that although technology has generally been beneficial, unintended consequences have been a problem. Freon and the ozone hole for example. So as technical capabilities increase, it would seem unintended consequences will increase proportionally as well.
JonF says:

August 7, 2012 at 5:54 am

Re: JonF, probably true, but at the present time Hawking radiation is only hypothesized to exist.

Hawking radiation is based on quantum uncertainty, which is bit more than a hypothesis.
TWylite says:

August 7, 2012 at 10:39 am

I happen to be changing programming jobs soon, and was courted by some recruiters working on behalf of NYC-based trading firms like this. The main reason they did so is that I am primarily a C++ programmer. C++ is a language where it is very easy to create bugs if you’re not very careful. I can believe that Manhattan and New Jersey where these firms are clustered is teeming with “brogrammers”: young cowboy coders, uniformly male, who think they can do anything given enough Red Bull or whatever stimulants they prefer. I might even would have liked to work at one of these places for a little while, just for curiousity’s sake. But even with a big bump in salary, I’d have to move my family from our Texas-sized house to an efficiency cardboard box in an alley.
MH - Secular Misanthropist says:

August 7, 2012 at 12:35 pm

JonF, remember that quantum mechanics and relativity are unreconciled theories. For example it’s not well understood how gravity behaves at quantum scales because it is normally not strong enough to matter, but that’s not the case near an event horizon.

So while it is true that quantum uncertainty has been observed, does it apply across the event horizon of a black hole? Until you measure Hawking radiation you don’t have any evidence to assume that. So Hawking Radiation remains a hypothesis.
Siarlys Jenkins says:

August 7, 2012 at 11:23 pm

The solution is simple. Whenever agreement is reached between a willing buyer and a willing seller, the deal is sealed for 90 days. At the end of that time, it is unsealed, the price is paid, ownership in the shares are transferred.

Ergo, both buyer and seller MUST look to long term investment potential, not momentary psychology, trading algorithms become almost irrelevant, and day traders have to get a job.