Remember the Flash Crash – the May 6 “unexplained” stock market dive?  Well, the Securities and Exchange Commission and the Commodities Futures Trading Commission now say they have found the cause, and nobody did anything wrong to cause it.  According to the NY Times, these commissions

“found no evidence of market manipulation. Instead, the temporary crash resulted from a confluence of forces after a single fund company tried to hedge its stock market investment position legitimately, albeit in an aggressive and abrupt manner” via NYTimes

This . . . is . . . insane.  I mean, read the rest of the report, and this conclusion seems like an almost willful departure from reality.  According to authorities, here is what happened:

  • A single mutual fund, Waddell and Reed, decided to sell $4.1 billion in futures contracts.  That’s a lot, but hey, it happens.
  • The sale of these funds, however, is insane.  To quote the Times, “The mutual fund started a program at about 2:32 p.m. on May 6 to sell $4.1 billion of futures contracts, using a computer sell algorithm that over the next 20 minutes dumped 75,000 contracts onto the market, even automatically accelerating its selling as prices plunged.”

In plain English, they decided to dump at all costs, without regard for losses or market impact.  The firm claims it was dumping the contracts because it was concerned about the European financial crisis spreading to the US – they found themselves long on a lot of trades in the contracts in question, and decided to get out while they could in the face of what they expected would be a reversal in the contract values.  OK, so maybe they got a bit jumpy . . . but the logic here comes apart when you look at the sale mechanism – they basically started dumping these contracts onto the market, creating an oversupply which would drive the contract price down . . . and they would keep pumping contracts into the market even as they exacerbated this problem.  In other words, they tried to offload these contracts to avoid losses when their value dropped, but the way in which they offloaded the contracts ensured their value would drop.  This is where the whole thing turns really nuts – they set up their sale algorithm to sell everything in 20 minutes.  They dumped $4.1 BILLION DOLLARS OF CONTRACT ONTO THE MARKET IN 20 MINUTES!  What the hell did they think would happen?  Hell, the only rationalization I can come up with here is that they hoped to dump it all so fast that they would actually beat the market collapse they were likely to trigger.

You cannot tell me that the folks running this fund did not understand what this sale, executed in this manner, could do to markets.  The justification of the sale structure is itself illogical on its face.  And the fact that these guys still have jobs, and have not been beaten to death (metaphorically speaking) by other funds for what they did (like many of those who shorted the 2008 financial crisis) makes me really wonder what the hell went on here.

But the SEC and the CFTC have turned into Officer Barbrady from South Park: “Move along, nothing to see here”

Which reminds me of a classic South Park exchange (South Park, season 2, episode 2):

Mayor: Officer Barbrady, let’s pretend for one second that we had a competent law enforcer in this town. What would he do?
Officer Barbrady: Hmmm. That’s a good question, Mayor. Let me get right on that, with thinking.