The SEC’s Broken Down Volkswagen


Back in January of this year, Gregg Berman from the SEC’s Division of Trading and Markets gave a speech where he took exception to the word “broken” when describing the equity market.  This isn’t the first time that we have heard folks complain about the “broken” word.  We often hear pro-HFT types say that there is nothing wrong with the equity market and it is surely not broken.  They will usually point to “abundant liquidity”, “tight spreads” and cheap retail commissions as signs of the health of the equity market.  While we know these pro-HFT guys are just hoping the market stays the same so they can keep profiting from it, we are concerned when hear a senior level executive at the SEC makes comments like this:

The markets are not broken. In spite of what you read everywhere, in spite of what many market participants say, and in spite of what many jurisdictions and other regulators might say about the equity markets, they’re not broken… I have a very good sense of what broken is and what broken is not. 

Three weeks ago Stephen Hough, international pianist, did a great concerto at Kennedy Center. Some of you might have caught that. My wife and I got dressed up, put my suit on, went to the garage, went to the Volkswagen, turned the key, nothing happened. It didn’t ding. It didn’t do anything. It just sat there staring at me, and I kept turning the key and nothing happened. Do you know why the car didn’t start? It was broken. That’s what broken means. “

We have a few questions for Mr. Berman about his broken down Volkswagen:

– Was it leaking oil?

– Did any warning lights come on prior to it not starting?

– Did he regularly get the Volkswagen inspected?

– Was his car making any strange noises?

Our point is, things don’t usually just break.  They usually give you warning signs before fully breaking down.  While Mr. Berman may be technically correct that the market is not broken based on the fact that trading occurs every day, he does seem to be overlooking some warning signs that the market is sending about a possible future break down. He seems to be overlooking the fact that the market engine is greased with oil that can quickly dry up.  He also doesn’t seem to have the proper inspection equipment to make sure the market is functioning smoothly.  While we give credit to the SEC for their MIDAS system, it simply is not enough to inspect a market that is this complex (the Consolidated Audit Trail will be an improvement but it is years away from happening).  Using MIDAS to inspect today’s market is like using a local gas station to inspect a Lamborghini.

The Flash Crash of 2010 was equivalent to Mr. Berman’s Volkswagen not starting before the piano concert.  The market broke on that day.  And while the SEC has put some new spark plugs in and tweaked the anti-lock braking system, the bigger issue as to why the market broke that day was never solved.  Considering that we wrote a book called  “Broken Markets”, we’re going to have to take responsibility for the term that is so loathed by the pro-HFT community and some regulators.  But we’re sticking by our title and we’ll continue to highlight the issues that we believe need fixing.