The Interesting Thing Is That the Drop Was Not "Instantaneous"...

Today in journamalism:

Today's Markets - WSJ.com: Global stock markets remained weak on Wednesday, but the selling pressure that swamped Wall Street late yesterday eased.... U.S. stock markets suffered their worst one-day plunge on Tuesday since Sept. 17, 2001, the first day of stock trading after the Sept. 11 terror attacks. The broad selloff was encouraged by weakness on the Shanghai market, disappointing economic data, weakness in the subprime lending market and rising uncertainty about Iran and Afghanistan. The Dow industrials -- briefly down as much as 546.20 points after a nearly instantaneous drop of about 200 points -- ended the day down 416.02....

But the Dow Industrials did *not* instantaneously drop 200 points. The ticker ran behind because of volume, and they had to switch over to a backup system, and this created the appearance of a sudden 200-point drop--not the reality of such a drop.

The news is not that the DJIA instantaneously dropped 200 points. The news is that Dow Jones, Inc., has not invested enough in infrastructure to be able to produce a reliable real-time index. Plus it's a really lousy index, as indexes go.

Comments

[elliottg]

No the real news is the arbitrage opportunity that was created by the divergence of the futures market and the underlying market. This divergence was fueled by the reliance on the non-real time ticker (until the backup system kicked in). The slide halted after the "instantaneous" drop occurred because the futures market corrected almost "instantaneously". In this case the correction of the futures market happening so rapidly and the disconnect because of the ticker lag until the backup system kicked in is the big story.

[anne]

Brad DeLong's observation struck me immediately on the market close.

Elliott, thank you for the fine comment which also struck me. The compensation of the future's market was impressive.

[jerry]

The problem is these indexes update too frequently.

Oh I lost a pound! Pie for Me!
Oh I gained a pound! D I E T!!!!
Oh I lost a pound! Pie for Me!

I think the stock markets should open once a week for a couple of two hours and then close. Trades should be 100% computer matched and performed after the market closes. All matching software should be opensourced and the trading software should be goal directed where the goals are somehow voted on in a non-secret ballot that takes place over six months the prior year.

[jerry]

Oh. Allow insiders to trade but make their trades known.

[Dean Witter]

You can get free access into that WSJ article with a netpass: http://news.congoo.com

It also works on Morningstar and FT.com and others...

[Andy]

In their defense, they did have an entire article on page A1 devoted to this phenomenon.

After a Rough Morning, A Data Backup Jolts The Blue-Chip Average
By SCOTT PATTERSON, AARON LUCCHETTI and RANDALL SMITH
February 28, 2007; Page A1

The stock market was having a bad day and, briefly, it looked even worse.

Spooked by a selloff of Chinese shares, the Dow Jones Industrial Average started the day under pressure. By midday, the average of 30 blue-chip stocks was already down around 200 points, and it continued to slide through early afternoon.

CHAIN REACTION
Suddenly, at about 3 p.m. Eastern time, the Dow industrials fell out of bed, logging one of their fastest declines in history. Behind the abrupt 200-point plunge: a glitch in the mechanism that calculates the average.

"The system fell behind," said Mike Petronella, president of Dow Jones Indexes, which is owned by Dow Jones & Co., the publisher of The Wall Street Journal...

[Ian Whitchurch]

The point is however that Shanghai sneezed and Wall Street caught a cold.

Ian Whitchurch

[Brian]

Did anybody else read the article in Slate about Rudy Guiliani, which mentioned that city hall still didn't have an e-mail system in 2002, even after he was mayor for all of those years?

[derek]

I don't get it. If that's the case, why did the NASDAQ and Standard & Poor 500 index drop at the same time without even a lag?

http://i146.photobucket.com/albums/r264/del_c/politics-charts/zs5EIXICt5dqllonzlc5EGSPC5EDJIpsavp.png

I can see it if you were saying the DJIA glitch *caused* all three indexes to drop, but I don't see any way you can say they did not in fact drop. It would be like saying that because everybody panicked at news of a bad banana harvest, when in fact the banana harvest was not bad, the panic did not happen.

What am I missing here?

[SalvatoreM]

Other websites have pointed out that it was probably due to broker executions of trades in customer margin accounts beginning at 2 pm. That would explain the simultaneous "glitch" in all three indexes, as well as the extraordinary volume at that moment.

[Alex R]

For kicks, go to a website with a good interactive charting feature (I used marketwatch.com, but I'm sure there are others), and chart DIA against the Dow. (DIA is an ETF that tracks the Dow.)

If you zoom in on Tuesday afternoon, you can see the DIA sliding, while the Dow putters along until 3 pm, then catches up.

[anne]

http://economistsview.typepad.com/economistsview/2007/03/paul_krugman_th.html

March 2, 2007

Paul Krugman: The Big Meltdown
Edited by Mark Thoma

Paul Krugman, looking back to today from March 2, 2008, analyzes the recent drop in U.S. stock prices and what it might mean for our economic future:

The Big Meltdown, by Paul Krugman, Commentary, NY Times: The great market meltdown of 2007 began exactly a year ago, with a 9 percent fall in the Shanghai market, followed by a 416-point slide in the Dow. But as in the previous global financial crisis, which began with the devaluation of Thailand's currency in the summer of 1997, it took many months before people realized how far the damage would spread.

At the start, all sorts of implausible explanations were offered for the drop in U.S. stock prices. It was, some said, the fault of Alan Greenspan, ... as if his statement ... that the housing slump could possibly cause a recession ... had been news to anyone. One Republican congressman blamed Representative John Murtha...

Even blaming events in Shanghai ... was foolish on its face, except to the extent that the slump in China — whose stock markets had a combined valuation of only about 5 percent of the U.S. markets'... — served as a wake-up call for investors.

The truth is that efforts to pin the stock decline on any particular piece of news are a waste of time. ... In 2007, as in 1987, investors rushed for the exits not because of external events, but because they saw other investors doing the same.

What made the market so vulnerable to panic? It wasn't so much a matter of irrational exuberance ... as it was a matter of irrational complacency.

After the bursting of the technology bubble of the 1990s failed to produce a global disaster, investors began to act as if nothing bad would ever happen again. Risk premiums ... dwindled away. ...

For a while, growing complacency became a self-fulfilling prophecy. As the what-me-worry attitude spread, it became easier for questionable borrowers to roll over their debts, so default rates went down. Also, falling interest rates on risky bonds meant higher prices..., so those who owned such bonds experienced big capital gains, leading even more investors to conclude that risk was a thing of the past.

Sooner or later, however, reality was bound to intrude. By early 2007, ... collapse of the ... housing boom had brought ... widespread defaults on subprime mortgages... Lenders insisted that this was an isolated problem, which wouldn't spread... But it did.

For a couple of months after the shock of Feb. 27, markets oscillated wildly, soaring on bits of apparent good news, then plunging again. But by late spring, it was clear that the self-reinforcing cycle of complacency had given way to a self-reinforcing cycle of anxiety.

There was still one big unknown: had large market players, hedge funds in particular, taken on so much leverage — borrowing to buy risky assets — that the falling prices of those assets would set off a chain reaction of defaults and bankruptcies? Now, as we survey the financial wreckage of a global recession, we know the answer.

In retrospect, the complacency of investors on the eve of the crisis seems puzzling. Why didn't they see the risks?

Well, things always seem clearer with the benefit of hindsight. At the time, even pessimists were unsure of their ground. For example, Paul Krugman concluded a column published on March 2, 2007, which described how a financial meltdown might happen, by hedging his bets, declaring that: "I'm not saying that things will actually play out this way. But if we're going to have a crisis, here's how."

[scootie]

Jerry.
Right on my brother.