International Forecaster Weekly

SEC Launches Glitchy Database To Prevent Another Flash Crash

Will this actually help prevent another flash crash? Will the database do what it's supposed to do?

James Corbett | November 18, 2018

Playing in the (manipulated and rigged) stock market is not for the faint of heart. Things can turn on a dime and that sure-fire stock you're riding today might just revert to its intrinsic value (i.e. zero) tomorrow.

But as exciting as the markets can be, they're rarely as terrifying as that 35 minute window from 2:32 PM to 3:07 PM on May 6, 2010, when the Dow plunged nearly 1000 points and then gained most of it back. Now known as the "flash crash," it was the largest single intraday swing in the history of the American markets and for a heart-palpitating minute a trillion dollars in phony baloney paper "wealth" had been simply wiped out of existence.

But as I've discussed in these pages before, the fine folks at the Securities and Exchange Commission! didn't let the market contemplate the significance of that incredible plunge for very long. Downplaying the incident with an explanation that they were "investigating," the SEC's finest returned with their DOJ and FBI pals a scant five years later to throw a scape goat in jail and sweep the whole affair under the rug. Problem solved, right?

Wrong. Of course. So the noble agents of the SEC got to work adopting a new rule that would require a Consolidated Audit Trail to "efficiently and accurately track all activity throughout the U.S. markets in National Market System (NMS) securities." Specifically, the dream was to build a "supercomputer" that would act—in the memorable words of SEC Commissioner Kara Stein—as the "Hubble telescope of securities markets."

So what does all that mean in plain English? A database. They are launching a database. Now, to be fair, this is a pretty big and complicated database. As you may or may not know, up to this point each national securities exchange has maintained its own audit trail for transactions, creating a mish-mash of reporting, misreporting and unreporting styles and standards that, one can imagine, make it a nightmare for the regulator types who want to be able to track each and every transaction flowing through the markets. So creating an audit trail with standardized data for all of those different types of transactions in all of those different markets and the cataloguing and storing all of that information is, to say the least, a daunting task

Good thing we have the government on this case! If there's one thing I know about governments, it's that they're good at coming up with on-time, functioning, sophisticated and elegant answers to highly challenging problems.  . . . Oh, wait.

Yes, as tempting as it is to write off Stein's "Hubble telescope" analogy as just another out of touch government bureaucrat trying to talk about technology she doesn't understand (series of tubes, anyone?), it turns out her analogy is more appropriate than she ever could have intended. Do you remember the Hubble telescope? You know, the space telescope that was launched into lower-earth orbit in 1990 with the promise of giving us the most breathtaking views of the universe yet? And do you remember when, upon its launch, it was discovered that it had a flawed mirror that impaired its ability to function? And how the repair of that flawed mirror cost a further billion dollars of taxpayer money and actually made the problem worse?

Well, guess what? The Consolidated Audit Trail has been a technical nightmare to get launched and, even now as it is going online, it suffers from critical flaws that make it mostly useless. As Dave Michaels at the WSJ helpfully explains:

The problem partly stems from certain options trades that can’t always be tied to the underlying orders that make up the transaction, one of the people said. Mr. Beller has told the exchanges that the flaw would be fixed by March 2019, the person added.

Without the linkages, investigators surveying for market fraud and analysts doing research for the purpose of improving market structures cannot see the full picture,” said Larry Harris, a financial economist at the University of Southern California who sits on an advisory committee to the project.

But don't worry, everyone. As I say, the technologically competent and business savvy folks in the government are good at solving these types of problems and I'm sure it's just a matter of time before this over-glorified $50-million-and-counting lemon of a database is up and running without a hitch.

So let's just assume that they can get the system functioning correctly with minimal cost overruns. Will this actually help prevent another flash crash? Will the database do what it's supposed to do?

Of course not. In order to actually help prevent another flash crash type of event, we'd have to assume that:

  • The SEC could be trusted to run such a scheme fairly.
  • The database did anything at all to address the root cause of the problem.
  • The technology actually worked.

There's just three problems with that little wish list.

  • They can't.
  • It doesn't.
  • It doesn't.

Need I elaborate? Oh, OK.

The SEC cannot be trusted to run this scheme fairly because they have already proven that they are willing to look the other way while companies deliberately flaunt the law. The details of that remarkable story are absolutely worth knowing in their entirety, so please go and watch (or re-watch) 20/20 Hindsight: Censorship on the Frontline, a great documentary that lays out the case step by step. Long story short, the very software that the SEC required companies to use to comply with the Sarbanes-Oxley Act had a back door that let those companies get around their compliance mandates. When this was pointed out to the SEC, they not only deliberately looked the other way but actually bought the very backdoor software that the whistleblower had tried to blow the whistle on.

The database will not address the root cause of the problem, which, as I've noted before, is:

"The high speed trading algorithms that now account for as much as 60 percent of the trading volume in the US futures markets. These computer-generated trades can function orders of magnitude faster than any human, reacting to changes in market direction and implementing buy and sell orders on the basis of that knowledge thousands of times per second. As the flash crash displayed, once the algorithms get tricked into selling into a plunge, the entire market can be plunged into chaos in a matter of minutes."

Sadly, just because these trades will be better catalogued (well, assuming they will be better catalogued), it does not change the fact that the markets are now at the whim of algorithms that can execute more transactions per second than any human being could ever possibly keep track of. By the time regulators come to solve the problem that these bots generate they could very well have wiped out the stock market itself.

And lastly, as we've seen, the technology is not yet capable of doing what it's supposed to do anyway.

So, in short, nothing has fundamentally changed, but tens of millions of dollars have been spent (not) fixing a problem! Sounds like business as usual for the Washington regulators.

What's that old saying? The nine most comforting words in the English language are "I'm from the government and I'm here to help."

That's how it goes, right? "Comforting." Well, something like that. I'm too busy to look it up. I'm off to invest in this red hot stock market! What could go wrong?