Listen Up Chris Dodd & Mary Shapiro – Richard Ketchum offers a solution!
On Friday, the Chief Executive Officer of the Financial Regulatory Authority (FINRA), Richard Ketchum, gave a speech at the Securities Industry and Financial Markets Association (SIFMA) Annual Compliance & Legal Division’s Annual Seminar. Given Thursday’s trading fiasco, he took a moment to recognize the fact that markets can break, and that fact must be recognized. Here is what he said:
“…recognize the simple fact that when liquidity disappears in markets today, it disappears absolutely. And that there are cliffs with respect to electronic books and there simply is not a level of expectations on how market making operates to ensure any modulation once you reach those cliff moments.
We need to step back and ask what that means. Whether it involves taking a brief break after a 15 to 20 percent drop in an extraordinarily short time or otherwise. There need to be shock absorbers in the market. We can’t be in this position of redesigning what happens in trades and making decisions in what trades should be broken with respect to markets that go close to zero. That isn’t an acceptable place.”
The most important element of these comments is the recognition that the system can and will break. The breakage is not due to algorithmic trading, high frequency trading, or any one of the multitude of economic problems the world is facing. No, the real culprit behind every market fiasco is human behavior and the persistent belief that our abilities allow us to out-smart everyone else.
Of the many deadly sins of investing, the single greatest is “overconfidence”. Proprietary traders, hedge fund managers, mutual fund managers and even the day trader suffers from a belief that they, and they alone, have a method to beat the market. Because they are certain that they have the answer, they fail to include any safety mechanism to recognize failure.
In today’s world, this undying belief in one’s capability, combined with the implementation power of computerized trading will result in one fiasco after another. The only way this can be minimized is through regulations. Mr. Ketchum calls them “shock absorbers” while the rest of us know them as circuit breakers. These circuit breakers need to be applied to all markets.
Mr. Dodd and Ms. Shapiro, both of you are in the drivers’ seats. You have the ability to recognize that human behavior is at the root cause of Thursday’s fiasco. It was the root cause of every major market meltdown since market trading began, and it will be the root cause of every market meltdown in the future. Take some advice from Mr. Ketchum and add “shock absorbers” to all markets before we once again fall off the cliff.
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