The Morning after the night before: the “flash crash” and the UK election

I was expecting to report some news today on the UK election. It turned out of course that there is quite a lot of news on that front but in terms of market news even this was overshadowed by what happened in Wall Street last night at around 7:40pm UK time. The best way  in which this can be represented is by this chart I am showing below. I would suggest you take a look at the bottom right hand corner.

When this was first shown to me I found it fascinating. You see what it shows is a market falling too fast for the technology to keep up (or at least Google’s charts!) and this is a very apt metaphor for what actually took place. For those who are unaware of what took place suddenly the Dow Jones plunged and it was quite a plunge making a total fall of 997 points. Now this is the largest intra-day fall for this index ever  in points terms although one has to be careful because it has fallen further in percentage terms (20% in the crash of 1987).

What does this mean/portend?

For this sort of thing to happen then you need the right circumstances and as I wrote yesterday

These sort of things thrive in such uncertain times and in a fearful environment some start to actually believe them. What was more realistic in my view was nervousness about the state of the interbank market and what might be happening there

In other words fear was the driving force of the drop. Now there are all sorts of stories about how this took place. I would counsel caution about some of them, I do not know about you but if I try to do anything electronic my system keeps coming up with “do you really want to do that?” so the idea that in a trading system someone can put billion rather than million and it does not get challenged does seem a little far-fetched. Indeed I once saw a rather amusing sketch which considered what would have happened if Microsoft had invented the car. You put your key in the ignition and you get “do you really want to do that?” you turn the key and get “do you really want to do that?”, you switch the windscreen wipers on “do you really want to do that?” and so on leading to the opinion that the motor car would never have caught on!

Also the argument that this was a pure glitch has to deal with the fact that the Dow Jones closed down some 348 points and it was followed by heavy overnight falls in Japan and Australia. This morning Europe’s equity markets are falling too. Other markets responded with oil falling US $3 per barrel and currencies were volatile.

The idea that Greece was the cause may be popular with TV stations but again is much less than a full explanation. The Greece story may have led to some of the fall but it is a long way from a full explanation. After all equity markets have shrugged off bad news from Greece on plenty of days recently.

The Cause

To my mind it was relatively simple. We have had the basic human emotion fear circling the markets for a few days and in that type of atmosphere some heavy selling pressure  which appears to have hit Procter and Gamble (an odd stock for fear to circle if you think about it) seems to have pushed things over the edge. However if you look at the exact times then there is a 7 minute period where the markets falls before anything happened to Procter and Gamble. So again this is much less than a full explanation.

As a further thought for you this is something that certainly was exacerbated by programme and computer driven trades. They will have responded automatically. There may well be considerable costs for people who trade with stop-losses and very mechanical hedge fund style trading could easily have come a cropper just like Long Term Capital Management in the late 1990s. As someone who was for a time a floor trader I was concerned about this sort of thing happening when computers and technology replaced human face to face trading. Whilst computers are plainly more efficient and cost-effective they also increase volatility in times of nervousness I feel.

This story will run and run but whatever anyone tells you the real driving force was fear. Also as many trading/analysis systems such as Yahoo and Bloomberg struggled one can say that technology could not cope with the implications of its own actions.

The UK Election

After a night of rumour and counter rumour it looks as though the UK is heading solidly into hung parliament territory which we have not been in since 1974. One could say that all 3 main parties lost. Labour plainly has had a heavy swing away from it and it has lost a lot of seats, indeed it is its worst result for many years. The Conservatives gained a lot of seats but look to be short of a majority. The biggest losers compared to expectations were the Liberal Democrats who after expectations of a surge during the campaign are now facing the prospect of losing seats.

In the UK constitution the existing Prime Minister has the first opportunity to try to form a government. Plainly giving the large loss of seats he will need coalition partners. However one unexpected factor is the weakness of the Liberal Democrats, so I feel that there will be some interesting negotiations. However I do not expect them to succeed for any length of time as the two parties together look too weak n terms of seats to actually run a government. But they may well try…

I noticed last night that some of the smaller parties (Unionists in Ulster) were preparing demands in return for support (in this case of a minority Conservative government) and we may see more of what I call the tail wagging the dog. I am not sure that such behaviour will improve the general sense of dissatisfaction with UK politics.

I also notice that some politicians seemed to draw strength from the improved voter turnout. This I saw as a disturbing feature as I feel that they are too willing to draw a line under the so-called “rotten parliament” which has just ended which leads to the suspicion that they feel they can go back to carrying on as before. The fact that the turnout was up is a good thing, but it would not surprise me at all if our politicians draw the wrong conclusion from it.

One nice touch was that the Queen said that she would not talk to anyone until after lunchtime today, well-played Ma’am.

I have suggested before that I thought that a hung parliament might make our politicians focus their minds on our economic issues. However whilst this is a very early stage it does not look like any party is in a strong enough position to cobble enough votes to govern. So we could get uncertainty for quite a while. If you want a historical precedent Ted Heath’s government in 1974 lasted for 3 days. So in reality we may well get uncertainty for a while which in my opinion is exactly what we do not need. Our economy needs certainty and action on the deficit.

Conclusion

The fear that is surrounding financial markets that I wrote about yesterday was put into numbers by the flash crash which happened on Wall Street later in the day. However there are concerns in other markets particularly the interbank markets which are showing signs of the sort of dislocation which preceded the fall of Lehman Bros. This therefore is not a good time for political uncertainty in the UK. If you look at our gilt market and our currency the markets appear to agree with this view

If you are looking for a wider world view the Bank of Japan last night pumped money into the markets in a type of measure to “increase markets’ sense of security”. I think that the story of money market dislocation is showing signs of rearing its rather ugly head again…

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16 thoughts on “The Morning after the night before: the “flash crash” and the UK election

  1. There is one thing we can be sure of for our politicians to provide, procrastination!
    Looks like we have just played straight into their hands!

  2. Shaun, great blog and very readable. Thanks.

    I think that your reference to a sketch where somebody theorised that a Microsoft designed car would be like a PC running MS Windows, stemmed from an actual incident, that happened in the 80’s. If my memeory serves me well. Microsoft at that time made a comment about the quality and outdated design of some of some GM cars, adding that they thought that Microsoft could do a better job than GM, if they were in the car manufacturing business. An engineer at GM cobbled together a reply and included the things that you quoted. However he also added a few more and in my opinion the funniest were:

    1) You are driving a Microsoft designed car at high speed along a freeway when you get a ‘blue screen’ condition and a message that the system has crashed and needs re-booting!.

    2) To stop a car designed by Microsoft you would have to hit the ‘Start’ button!.

    Keep up the good work and thanks again.

  3. A number of Economists have today now warned that the UK’s present AAA credit rating is now imminently under threat, as a result of the present hung parliament uncertainty (despite limp assurances given by the Rating Agencies). If this is so then I feel things could begin to hot up a bit for the UK?

    • I think we will have to see some very creative accounting considering the QE funded debt pile if we are to retain AAA.

  4. Regarding Greek banks: at least one a couple of days ago was quietly “managing” customer withdrawals(i.e. an upper limit of 700 euros that day). They got a small short term loan possibly from the bog. The only explanation is that this bank which is a borrower on the interbank market lost easy access to overnight funds. If the fear factor hypes wildly before the Greek deal kicks in(i.e. side deal for Greek banks) we could see an all out bank run in Greece.

    Pay cuts kick in June 2010 so expect heightened tensions in the streets. The event 2 days ago was just the beginning. Molotov cocktails are brewing in everyone’s minds. The next spark will trigger unprecedented events. This is what Europe fears most. An example of what people can be capable of when they are backed into a corner.

    Here comes the summer of discontent!

  5. Some serious rumors on this side of the pond today Shaun:

    “the WSJ’s Jon Hilsenrath has reported that the Fed is considering reopening swap lines with central banks, likely in conjunction with the rumored rescue package. This is the news that shot the market up in the last 10 minutes of trading as the Fed would never allow the market to close at the days lows, as it was preparing to do. “Apparently New York Fed President Dudley and Vice Chair Don Kohn are in Basel this weekend for an already scheduled meeting with European central bankers. A Sunday announcement seems like a growing possibility.”

    http://www.zerohedge.com/article/fed-preparing-bail-out-world-again-wsj-reports-dollar-swap-lines-likely-be-reopened-fed

    Earlier on ZH was a rumor of the ECB bailing out 1,100 European banks

    Just rumors, but Hilsenrath is a fairly well respected journalist..

    • Hi Mr. Kowalski
      There were plenty this side too and not only about our election and hung Parliament! The G7 telecon rumour appeared to come true although in my opinion they had little or nothing to contribute at this stage. A swap arrangement deal if it takes place is likely to be complicated and opaque however. The central banks of the world do not make tracking them down easy and there when they started this game for the credit crunch there were swap lines everywhere and made my head spin a little! I was interested in the monetary policy implications at that point and they remain a theoretical construct that is something to ponder for an economist like me…. As an example the swap deals from the Fed to other central banks in $ were reasonably clear but why the Bank of England offered such deals in £’s and the Bank of Japan in Yen was much less clear

      As to the ECB well if I was in charge I would certainly have a plan ready for supplying liquidity just in case. I would be very annoyed about leaks because discretion should be the watchword of a central banker. However I would be (and believe the ECB already is) supplying any overnight money the Greek system wants or needs. In reality the ECB if pressed could simply reactivate its emergency plans from the credit crunch although I assume that there would be political pressure against this as of course it would be a clear sign that we are not out of the woods…

  6. Hi Mr.Kowalski et all,

    Very important news: The German federal court has today rejected the claim against the German government help to Greece. Giving the German government a free hand in dealing with the Euro crisis.

    Tunes have suddenly changed as well. The president of France has apparently taken the lead in the talks (according to the German news) and has hushed his German colleagues. Some German politicians have suddenly come on German television saying: ” No price is too high to save the Euro “. Even our Dutch prime minister has changed his tune. An interview with the Luxembourg prime minister on German television he said: ” We stand together, we fall together. We will do whatever it takes to save the Euro.” even Trichet has been summoned to join the talks today. Quite some dramatic news scenes on German and Dutch television in this regards. And appearently the French president is running the show.

    Some wild rumours are about the cration of single Euro zone bonds for the countries in trouble issued by the European commission. Although they could only provide a total additional package of 100 Billion Dollars. More importantly, some journalists claim, the ECB is going to be allowed to go nuclear. Backed by all the creditor nations in the EU. That package is estimated to be over a wopping 1000 Billion Dollars.

    Amazing numbers are comming out and I have seen quite white faced politicians appear on television. Is there something they just found out that we do not know? Or did they just discovered the numbers do not add up anymore and there is real need for action.

    I looked at some numbers in an attempt to figure out why the French president “suddenly” took this dramatic lead. Appearently, (do not know the reliability of these numbers: http://www.scribd.com/doc/31010225/Euro-Debt-Crisis) France has lend a staggering amount of 950 Billion Dollars to the debtor nations in trouble. Germany has lend them 704 Billion. And worryingly for the Pound the UK has lend them 418 Billion Dollars.
    If the exposed nations take a real hit next year and go bust, France her entire banking system is too exposed and will likely topple as their banking system cannot take that amount of strain and that could take out the entire Euro area in one single blow. At least to some pundits on television. Even a haircut on that amount will severly damage the French banking system.

    “Luckily” for the Euro-area debtors and creditors, the debt is held in Euros inside the Euro-area and thus free from currency speculators, so if an intra Euro area action including the ECB is taken the situation could be stabalised inside the Euro-area. I do not know the consequences of such actions on the Pound.

    I find it all very unsettling to see this Shakespearesque drama unfold. So as to quote, is this “The beginning of the end, or merely the end of the beginning” for the Euro? Personally, I hope the latter and I hope it will be stronger after the crisis than before.

  7. “Amazing numbers are comming out and I have seen quite white faced politicians appear on television. Is there something they just found out that we do not know?”

    Their economists have likely described to them what happens when currencies collapse.. ie.. the possible collapse of social cohesion.
    This is no joke, folks.. even during the Depression, the currencies held value and social cohesion remained. This time, it’s the currency itself being attacked, compounded by CDS’s which threaten the banking system as well.

    • Hi Mr. Kowalski, Johan and Andy
      I am monotoring what is going on and waiting for some actual detail from the EU. I have for example spotted the words of the French President Nicholas Sarkozy ““When the markets re-open Monday, we will have in place a mechanism to defend the euro. If you don’t think that’s significant, you haven’t been to many EU summits.” However of course the hyperbole count from European ministers and officials has been nearly as high from their own previous failed plans and so far they have trumpeted plans which at best have disappointed….

      I have two main initial thoughts. Firstly concerning the ECB that this weekend is likely to be very significant for it. If the deeds even remotely match the words they will be trampling on the ECB’s toes in one form or another and it was only Thursady afternoon it decided not to act on these subjects! So we are back to credibility issues. I think also that the issue of the ECB not having a fiscal partner in the way that the Fed has the US Treasury and the Bank of England has the UK Treasury and in particular the fact that this means it is limited in its ability to take losses will be significant today as they settle the plan. So here is my first thought if this plan is going to have a chance of working the EU should guarantee the ECB financially. I think using the European Commission would be a poor alternative.

      The second is slightly uncertain because it is by no means absolutely sure that the UK will have a Conservative government. But if we do there has been circulating in London a draft EU policy and if you read it (and it is true) then they would turn this deal down. According to the Guardian newspaper “But the British relationship with the EU has changed with our election. We will never join the euro. We will introduce legislation early [I won’t pre-empt the Queen’s Speech with detail] to implement our commitments: any Treaty change transferring competence or powers would require a referendum; the sovereignty bill; and increased parliamentary controls on any use of ratchet clauses”

      So there is much which may happen…

  8. It sounds like judgement day is upon us?

    Stability funds are now a waste of time (and 13 years too late).The situation is binary .The ECB either backs default or printing press inflation big style.My money now is on the latter with Germany to exit.

    Again we have a choice, disaster or disaster.

    I doubt the political uncertainty could have come at a worse moment for the UK. This is scary.

  9. I too think this is a scary situation.
    Looking at what has been sheer incompetence up until possibly now by the Eurocrats, and now maybe being too late or at least costing everyone way above what it could have done, have they really had their ‘road to Damascus’ experience or have they been told to fall into line? Trichet has consistently been behind the curve, allowing events to dictate, is he really about to take charge and start to shape events going forward? Looks to me like the wrong people being in the wrong posts at the wrong time. They seem lost in a morass of their own failings and instead of any innovative solutions they are stuck in the rut by their own blinkered thinking.

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