But all of this changes market microstructure in insidiously destabilizing ways. For the first time we have large providers of this shadow liquidity, algorithms and high-frequency sorts, that individually account for large percentages of daily trading activity, and, at the same time, that can be turned off with a switch, or at an algorithmic whim. As a result, in market crises, when liquidity was always hardest to find, it now doesn’t just become hard to find, it disappears altogether, like water rushing out [of] sight via a trapdoor to hell.
This is not a particularly helpful article, in terms of explaining what happened and how. It is undoubtedly better, however, than what we can expect from our grandstanding political class as they hold hearings next week.
I really wish we could take a very detailed, objective look at what happened on Thursday, without needing to name somebody as the “villain” and punish them while the White House and Congress anoint themselves as the virtuous “saviors” of everyone’s 401k.
Program trading can increase short term volatility but that is the flip side of increasing short term efficiency in moving information through the market. However, program trading does nothing to the underlying value of equities. It does not change sales. It does not cause corporate assets to be transferred somewhere else.
The current instability is due to the complicated and hidden long term relationships that define the amount of risk associated with assets. Perhaps some banks or insurance groups are too big to fail but the closely related problem that must be solved is ensuring that the markets have sufficient information so that efficient market theories can have a chance to approximate reality.
The “free market” is supposed to work because of the cumulative impact of millions of independent decisions/choices by made by millions of individuals.
Somehow this seems incongruent with machine controlled decisions based upon algorithms decided upon by small cliques of individuals.