U.S. regulators and exchanges provided tantalizing clues but few firm answers on what set off last week's stock market plunge, the first major breakdown in a brave new world ruled by trades timed in milliseconds.
Summoned to Washington for a special congressional hearing, regulators said Tuesday they had not yet determined what triggered the harrowing move, which wiped out $700-billion (U.S.) of market value in less than 10 minutes on May 6 before abruptly switching direction.
But they promised swift action to prevent a repeat of what was a "profoundly disappointing and troubling" episode in the words of Mary Schapiro, chair of the Securities and Exchange Commission.
Ms. Schapiro pledged to remedy the lack of co-ordination between trading venues on how to handle moments of market stress, which magnified last week's tumble. In particular, she said new industry-wide rules on when to curb overall trading and activity in individual stocks would be adopted soon.
Several potential culprits for the slide are looking increasingly unlikely, regulators said. The disruption in market does not appear to have started with a so-called "fat finger," the term for a trade mistakenly entered with a flawed quantity or price. Nor, apparently, did it begin with an especially large transaction in a particular stock. There was also no sign of computer hacking or cyber terrorism, they said.
Tremors were evident in the market in the half-hour preceding the decline, said Gary Gensler, chair of the Commodity Futures and Trading Commission. Currencies were volatile and small-cap stocks started sinking fast, which halved the value of eight mutual funds in less than 30 minutes.
If the markets were an airplane, Mr. Gensler said, such changes were the equivalent of indicator lights flashing. Then the plane lost an engine, he added, when certain players in the market stopped trading, decreasing overall activity.
The CFTC is scrutinizing the trading in futures contracts tied to the Standard & Poor's 500 index, which are known as "e-minis," focusing on the ten largest players betting in each direction on the instruments.
Executives from three major exchanges said they, too, had not found a precise cause for the market volatility. "It's understandable everyone is looking for a smoking gun," said Larry Leibowitz, chief operating officer of NYSE Euronext.
Last Thursday's aberrant market moves illuminate the breathtaking changes that have occurred in the stock market in recent years, a shift whose ramifications are only now becoming apparent to investors and regulators.
Once dominated by two stock exchanges in New York, there are now more than 40 U.S. venues for investors to buy and sell shares. Many such trading platforms cater to a breed of investor who prizes speed above all as part of a strategy to wrest profits from thousands of trades per minute.
Such "high-frequency" traders now make up an estimated two-thirds of the trading volume in U.S. stocks on any given day, according to a study last year by Aite Group, a financial research firm.
For these traders, the buzzword is "latency," or the time that elapses between when a trade is ordered and when it is executed. In pursuit of ever lower latency, some such investors and brokerages that cater to them have moved their servers physically closer to electronic exchanges to shave the time it takes for orders to be completed.
The upside of the growth in such rapid-fire trading is that markets are more liquid, meaning there are more buyers and sellers at any given price, which compresses the cost of doing business.
On the other hand, it can lead to unanticipated vulnerabilities like those that surfaced last Thursday afternoon. "You have complex agents interacting with each other very quickly," says Ciamac Moallemi, a professor at Columbia Business School. "It's hard to foresee the things that could go wrong."
In a letter to regulators last year, New York-based Lime Brokerage, which specializes in high-frequency trading, warned that more safeguards were needed in a situation where traders were able to place upwards of 1,000 orders a second. Otherwise, it wrote, "the next 'Long Term Capital' meltdown will happen in a five-minute time period."
Terrence Duffy, chairman of the CME Group, testified at the hearing that judging from the activity on his exchanges, he saw no reason to blame last Thursday's fall on high-frequency traders. They "provided liquidity on both side of the market on this extraordinary day," he said.