The Sky Isn't Falling: Marking the First Anniversary of the Flash Crash

One year ago, on May 6th at 2:42 pm, the U.S. equity market went into free fall. In just five minutes, the "Flash Crash" sent the Dow Jones Industrial Average, already down 300 points on the day, plummeting by an additional 600 points, for a total decline of 9 percent.

Twenty minutes later, the DJIA had fully regained its 6oo point drop. And while everybody with a stake in the market was still startled by the experience, the question on the table was simple: What happened?

The one year anniversary will bring out the doomsayers attempting to sell a story about fundamental flaws in the structure and operation of the U.S. equity market. To hear most of them, Chicken Little is alive and well.

But is the sky really falling, and ready to fall again? The facts suggest otherwise.

Less than two trading days after the Flash Crash, the market was establishing higher prices than those at the close of May 5th. Those forty five minutes were a very unpleasant anomaly, but they occurred in a market whose fundamental structure has remained resilient even in times of great stress.

A 600-point anomaly? Absolutely. The crash was the result of a remarkable confluence of unpleasant events creating short-term mayhem in the markets.

First, Greece was imploding on our television sets. Demonstrators were rocking the streets of Athens, with the possibility that instability would spread to other European countries whose governments had run up huge sovereign debt. The euro hung in the balance.

Then a large mutual fund complex launched a huge sell order into a sharply declining market with what appeared to be very little adult supervision. Either event alone would have driven the market appreciably lower; the combined effect was certain to be bigger than the sum of its parts.

Next, the NYSE triggered its Liquidity Replenishment Points status due to the volatility. However well intentioned, the effect was to remove the largest pool of liquidity from the market, forcing orders towards tertiary markets where there was little to no liquidity. To further complicate matters, the market data being published by the exchanges - upon which traders base their decisions - was believed to be flawed which further inhibited trading. As orders to sell at the market price couldn't be executed, because buyers weren't available, stock valuations continued to plummet. Thus, the Flash Crash.

Though anomalous, the events of May 6th did warrant a systemic response. And a proper one was forthcoming. Market makers were given new responsibilities (with more likely to come), and uniform circuit breakers were installed to pause trading in stocks showing sudden sharp increases or decreases in price. Additionally, we will likely see the introduction of so-called "limit up/limit down" trading parameters. SEC regulators should be applauded for these appropriate and measured responses. They have taken much of the systemic risk out of the conversation.

No doubt some of the doomsayers will demand that even more be done. A common theme emerging from some of the exchanges might best be described as "back to the future." They argue, in the interest of orderly markets, for regulatory fixes that would effectively push more trading back to the exchanges - in other words, for less competition. While that might help their individual business models, there is no data to suggest such a move will reduce risk or serve customers better.

The regulatory environment has long been moving the other way, in the direction of more competition, propelled by advances in technology. From 2004 through 2010, the NYSE's market share of trading in NYSE-listed stocks fell from 81 percent to 24 percent. Over the same period, NASDAQ's share of trading in NASDAQ-listed stocks fell from 49 percent to 30 percent.

The competition has been great for retail investors, in particular. In 2001, the average execution speed of a retail stock trade was 18.1 seconds. By 2010, it was 1.9 seconds. In 2010, 55 percent of retail trades were executed at a price improvement for the seller or buyer, compared to 26 percent in 2001. Commissions for online and broker-assisted retail trades fell approximately 60 percent between 1996 and 2009. Speed, certainty and price improvement are in; getting "handled" is out.

For those of us working in the markets every day, it is clear that the U.S. equity market works exceptionally well. Investor choice has been especially well served over the past decade, and trading efficiencies continue to grow. The Flash Crash shouldn't be an excuse for a return to less competition, poorer execution quality and higher costs.

The time has come for the SEC to get credit for the way it has overseen the U.S. equity market. It is also time for the SEC to move on to the more pressing matters of Dodd-Frank and to cast aside assertions that the structure of the world's finest equity market is fundamentally flawed.

Rather than falling, the sky is in fact brilliant and clear.