Tags: May Flash Crash | oil trading | high frequency traders | Financial Services Modernization Act of 1999 | The Commodity Futures Modernization Act of 2000

The Flash Crash Culprit? It's Oil

By    |   Friday, 08 Jul 2011 09:11 AM

As many of you are aware, an article of mine was published by Newsmax six hours before the "Flash Crash" of May 6, 2010 (http://www.moneynews.com/StreetTalk/barry-elias-dow-divested/2010/05/06/id/358019 ).

This piece included my rationale for exiting the equities market days before the “Flash Crash.”

A prescient decision, indeed.

Recently, the Commodities Futures and Trading Commission (CFTC) released its investigative findings of that day.


The study indicates only 5.5 percent of oil trading volume is based on long term investment and does not contribute to price volatility. 


The remaining 94.5 percent of the trading volume creates price volatility, and the trades are based on "arcane price relationships."

This assessment is well aligned with my previously held contention: high frequency trading actually increases price volatility, not the reverse as proclaimed by high frequency traders (HFT).

High frequency traders claim their actions promote effective and efficient markets: the antithesis of reality.

The rationale: The  HFT search the market for buyers willing to pay a price above the equilibrium market rate (they are optimizing the excess demand).  When this trade is executed, the new, higher price is not reflective of the market equilibrium. As such, this higher price cannot be sustained for a long period of time. The price necessarily reverts back to the market equilibrium. 

The result: price volatility and increased trade volume.

Notional (Face Value) derivative volume increased nearly sevenfold from $100 trillion in 2000 to $700 trillion in 2008. This was the result of legislation enacted in 1999 and 2000 under President Bill Clinton.

The Financial Services Modernization Act of 1999 (Gramm-Leach-Bliley Act) repealed a portion of the Glass-Steagall Act of 1933. This permitted financial institutions to function as investment banks, commercial banks, and insurance companies, concurrently. 

 

The Commodity Futures Modernization Act of 2000 deregulated over-the-counter derivatives. The legislation ensured that these financial products would neither be regulated as "futures" by the Commodity Exchange Act of 1936 nor as "securities" by federal security laws. As a result, dealers were not required to maintain adequate capital to insure appropriate counterparty payments (i.e., the losers pay the winners in a timely fashion).

What ensued was excessive, highly unregulated trading in low-value, high-risk financial derivatives. 

The result:  low value creation, excess wealth transfer, and a financial catastrophe that decimated our socioeconomic construct.

The Federal Reserve estimates the financial industry contributes roughly 1 percent to GDP, yet profits (not including excessive compensation) represent 25 percent of the total.

The top 1 percent of income earners received 8 percent of total income in 1980. Today that figure is more than double, approaching 20 percent.

The underlying cause of the crisis: a values deficit.

In recent decades, society placed a premium on materialism, rather than knowledge and wisdom. This is clearly reflected in our deteriorating education system and manifested by today's mismatch in the supply and demand for labor (i.e., college graduates do not possess the requisite skills required by industry).  

These ill-fated dynamics occurred over many decades. The correction may take as long to realize.

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Elias
As many of you are aware, an article of mine was published by Newsmax six hours before the Flash Crash of May 6, 2010 (http://www.moneynews.com/StreetTalk/barry-elias-dow-divested/2010/05/06/id/358019 ). This piece included my rationale for exiting the equities market...
May Flash Crash,oil trading,high frequency traders,Financial Services Modernization Act of 1999,The Commodity Futures Modernization Act of 2000
587
2011-11-08
Friday, 08 Jul 2011 09:11 AM
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