Flash Crashes and Gold Bitcoins

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Happy birthday, Flash Crash!

Five years ago today, stocks went down a lot, and then went right back up, all within the space of a few minutes, possibly in part because of some spoofing in London. Two things I generally think about the flash crash are:

  1. It's bad, but not that bad: If stocks go up and down a lot in a few minutes, then only those with a few-minutes-or-less time horizon will be harmed, and I am mostly unmoved by their plight.
  2. It is relatively trivial to fix: You don't need deep soul-searching into market structure to prevent flash crashes; good circuit-breaker/limit-up-limit-down rules are enough to prevent a flash crash from doing any serious damage.

To celebrate today's anniversary, the Wall Street Journal checks in with the Consolidated Audit Trail, one of the Securities and Exchange Commission's efforts at deep soul-searching into market structure. It "has been a complete mess from the very beginning," according to a former bidder for the contract to operate it. I guess that's what you'd expect. On the other hand, since the flash crash, there are new and improved limit-up-limit-down rules, which do a lot to reduce the risk of future flash crashes, even if our deep understanding of flash crashes has not improved much.

Elsewhere in market structure.

My Bloomberg View colleague Michael Lewis argues at Vanity Fair that high-frequency traders provide price improvement to retail investors because they are trading with those investors at stale prices. Everyone I talk to seems to think that (1) that happens but (2) not that much, or at least not enough to make it a business model. (Many people also think that it would violate internalizers' best-execution obligations, though that is perhaps a bit less clear than it ought to be.) The main reason that internalizers can price improve for retail orders is that retail order flow is not particularly informed or informative -- if you're buying 100 shares in your E*Trade account, that's probably not going to push the price up -- and market makers want to avoid adverse selection by interacting with uninformed order flow. If you sell shares to a retail buyer, you tend to make the spread, or the spread less a little bit of price improvement; if you sell shares to David Einhorn, you tend to get run over. I've recommended this paper before, and I will again; it's good to have a sense of the economics of market microstructure before deciding which bits of it are unfair.

Meanwhile, somehow the Commodity Futures Trading Commission "lacks resources to conduct even routine inspections of the exchanges and other companies it polices." And here's a new spoofing case. It's against two traders in the United Arab Emirates, who the CFTC says spoofed gold and silver futures contracts in the U.S. They did not manage to cause a gold or silver flash crash, as far as I know.

Hedge fund earnings.

I wrote yesterday about the annual ranking of hedge fund manager earnings, and so did Cliff Asness, though only one of us has ever appeared on the ranking. We came to similar conclusions about these "earnings"; as Asness puts it, "One way to make a lot of money is to start out with a very large fortune and make any non-trivial positive return on it."

In other hedge-fund news, "April was not a kind month to hedge funds," according to Morgan Stanley; this Wall Street Journal article paints a picture of hedge funds chasing momentum in various macro areas -- the dollar's rise against the euro, falling bund yields and oil prices -- and then losing money when the trends reversed. I guess that's why they get paid the big bucks.

Gold bitcoins!

Here's a story about a cryptocurrency called the Hayek that is backed by gold. It seems to be the sort of paranoid nonsense that you'd expect when you read "a cryptocurrency called the Hayek that is backed by gold." But it sparked an interesting (to me!) discussion about whether the notion of a cryptocurrency backed by an asset can actually make sense. The majority view is no: You need some sort of central depository to hold the asset, and so you need trust in the depository, which destroys the whole no-need-for-centralized-trust benefit of bitcoins. And since the centralized depository is the one actually redeeming the cryptocurrency into the asset, it just needs its own ledger of who owns the currency, so the whole proof-of-work blockchain apparatus of bitcoin is unnecessary. All it needs is a list of who owns how many whatevercoins; banks and exchange-traded funds, for instance, manage to maintain ledgers of their depositors and shareholders without needing blockchain technology. 

But there is an argument that some form of blockchain technology -- making transactions encrypted and publicly verifiable, though probably relying on the depository rather than a mining network to maintain the ledger -- could increase the transparency and reliability of the depository, and the efficiency of transacting, even if you'd ultimately have to rely on the depository not running off with all the underlying assets. I find myself somewhat persuaded that an asset-backed cryptocurrency might not be categorically nonsense, even if the Hayek itself is.

These strike me as important questions if you think that bitcoin's blockchain technology might have useful applications outside of the bitcoin currency itself.

The SunGard also ariseth, and the SunGard goeth down, and hasteth to his place where he arose.

"SunGard’s 2005 takeover by a who’s who of private-equity firms helped kick off the era of big buyouts" and now it is considering going public again, which would I guess put a period on that era. This would be a milestone both for the private equity markets and for my own life. I started in M&A law in 2005, and I guess I've now seen one cycle from the rise of the big private equity club mega-deals to their dismantling. And a financial crisis and flash crash along the way.

A poem.

Reader Tim Kubarych sends this poem about the Berkshire Hathaway annual meeting:

Capitalist County Fair
Book early! Scour deals. The crowd here's devout.
On this weekend, even private, it's the busiest of route.
Rise early, race over, and beat the long line.
Breakfast of packaged muffins will be divine.
In the video, showcase culture. Not Scrooge, but still miser.
Free work by Gecko and Mayweather is the common divisor.
Endless questions ensue from knowledgeable and naive alike.
Spans climate change, sugar count, and future rate hike.
Incredible stamina to address these, or tough ones belittle.
Pausing only occasionally to chew more peanut brittle.
Use break time for shopping throughout the great hall.
Super computers, jet planes, Coca Cola: an incredible mall.
Even without the jolly Warren or stern side kick,
The structure is sound. Shareholders needn't care a lick.
As long as you love your managers and large float remains,
Post succession legacy will be above market gains!

Things happen.

People are worried about bond market liquidity. The ECB is considering "whether to raise discounts on the collateral Greek banks pledge in exchange for emergency funding." Société Générale and Crédit Agricole reported good earnings. So did Herbalife. John Cassidy talks with Anat Admati about her "Finance & Society" conference. "No, stocks aren’t a good inflation hedge. Try bonds (really)." SAC Manager's Tipper Says Newman Voids Plea, Sentence. Details of HP Lawsuit Against Autonomy Executives Emerge. "Twitter gives control of its hapless marketing department to its chief financial officer." J.P. Morgan’s Barista-Turned-Banker Sees Good Things Brewing. Never Mind Oil, Iran’s About to Shake the World Pistachio Market. Snoop Dogg (Lion?), Ashton Kutcher, Justin Bieber, Bono, and other venture capitalists. "Why I left New York and also technology."

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This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net