Complexity (Again) Rears Its Ugly Head on Wall Street

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This week we saw a huge swing in the stock markets. Being an investor rather than a trader (my livelihood in retirement depends on the assets I hold), I saw my future flash in front of me. And the future was not so good. How could the markets drop a thousand points in an instant? At first, it seemed that it might have been caused by a trader mistakenly typing a “b” instead of an “m” multiplying an order by a thousand fold. The ‘b” key is only two away from the “m” key of a QWERTY keyboard.

Today the news is different, discounting this possible cause. The NYTimes reports on an ongoing investigation by several agencies charged with keeping the financial markets from exhibiting such erratic behavior—erratic as opposed to volatile which is a normal feature of these markets, especially in times when the economy of whole countries, like Greece, seem precarious.

The current explanation, still unconfirmed, is that the way the different computers that automatically match buyers and sellers started to interact in strange and unexpected ways. With deregulation, not only did banks depart from their historical norms, but new stocks markets were added to the old giants. Each now has its own computers. All of the computers are somehow linked so that when one get bogged down, action shifts to others. Rules to prevent runaway conditions, which have been around on the big, old exchanges for a while, don’t seem to be part of these newer systems.

The pressure in the less-liquid markets was amplified by the computer-driven trades, which led still other traders to pull back. Only when traders began to manually respond to the sharp drop did the market seem to turn around, said the official, who spoke on the condition of anonymity because the investigation was not complete.

Now a few days later, answers are yet to come. To me that is not surprising, but to Wall Street it’s a source of frustration. It seems from the news story, that Wall Streeters expect answers right away.

But, maddeningly, the cause or causes of the market’s wild swing remained elusive, leaving what amounts to a $1 trillion question mark hanging over the world’s largest, and most celebrated, stock market.

The expectation that a quick answer should be forthcoming is another sign that the financial markets, including the humans that manage the system and the computers that do the work, are seriously misunderstood. The search for an unitary answer is an inappropriate response to a failure in complex systems, such as are these human and electronic systems that comprise the financial markets. Complex systems are, by their very nature, so intricately interconnected that it is generally impossible to isolate the one, single cause. As layer on later of interacting pieces are added to the system, as derivatives exemplify, the system becomes less and less amenable to analysis, eventually confounding all attempts to reduce the workings to a set of determinate rules. The more accurate way to discuss and govern these systems is not as in “too big to fail.” but, rather, as “so complex that they are bound to fail.”

In Wall Street’s drive to become more and more efficient and thereby more profitable, the needs of Main Street investors, like me, has, unfortunately, been submerged. I need a little less risk, knowing that this goal comes with less return. I have built my portfolio, accordingly, but my intentions are overwhelmingly dependent on the actions of the traders and bank presidents who have built this house of cards and who take no prisoners.

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David M Carter said:

John,

I certainly don't mean to pick on you, but wealth preservation through free markets is the last bastion of the environmental scoundrel. I too have yet to adequately address the fact that we (investors) are complicit in the corporate world's decimation of our natural environment. By holding on to the hope that our accumulated wealth, at the expense of the environment, will provide security for us in the future, we are being disingenuous that we truly care about what has happened through our decades of living unsustainably.

Corporations today, even the "green" ones focused on developing sustainable products, are focused on wealth accumulation and preservation at the expense of all else. I know from experience with my own employer that the economic realties of today have "forced" its executives (the preservers of the wealth) to backtrack on sustainability initiatives in order to preserve wealth and profits.

It will take until we recognize that it is immoral to benefit from the abuse of the living system of which we are all a part before we will truly stem the tide of unsustainability. We cannot hold on to the hope that our misbygotten wealth will provide for us. It is simply wrong, and we are hypocrites for perpetuating it.