MarksJarvis: Nasdaq crash underscores frailties of overwhelmed system

Latest glitch could spur action to make markets less prone to a crisis

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For three hours Thursday, investors were locked out of buying and selling thousands of stocks when a glitch caused a shutdown of the Nasdaq market.

Trading resumed near the end of the trading day, with average investors seemingly unscathed. Yet, the breakdown became the newest reminder of frailties in a system that is dominated by computers and, with worrisome regularity, overwhelmed by the demands put upon it.

The Nasdaq freeze has reignited calls for regulators to do more to protect investors from meltdowns. Previous disasters include the $1 trillion "flash crash" of 2010 and Facebook's 2012 initial public offering mess, both of which unnerved individual investors. These crises are being used as evidence that the infrastructure at the heart of how stocks are traded is not strong enough to handle complex current demands coming from frenetic trading by sophisticated computers.

The cause of Thursday's glitch is unknown, though Nasdaq linked it to a connectivity issue involving an unidentified exchange participant. Whatever the fallout, it could have been worse.

"Most of the East Coast is still on summer vacation, so the volume and calls were light," said Steve Quirk, senior vice president of the TD Ameritrade Trader Group. From the individual's perspective, he said, the impact was like a day of watching television that was recorded instead of viewed live. If individuals wanted to buy or sell a stock as the market froze, the orders were recorded and then executed when the market reopened.

The day could have turned much darker for investors and the economy if, for example, an alarming piece of economic news had been released just before the freeze. Investors might have been frantic to sell during the three-hour wait. A rush to sell stocks could have caused the stock market to plunge. A huge range of stocks, including Apple and Microsoft, are traded on Nasdaq.

Concerns, however, are not focused on Nasdaq alone.

"All markets take a hit in reputation when this happens," said Larry Harris, a University of Southern California finance professor.

Numerous public opinion polls have shown individuals leery of the stock market the last few years because of the financial crisis and the flash crash. Yet Quirk said a recent Ameritrade survey showed that while 52 percent of individuals are more cautious about investing in stocks than they used to be, 92 percent didn't think technological glitches were a major concern.

David Lauer, a former Citadel high-frequency trader who testified at a Senate Banking Committee hearing last summer that the "equity markets are in dire straits" because of frenetic trading and inferior regulation, said Thursday that he hopes the latest tech foul-up will get regulators to take action to make the markets less prone to a crisis.

One trader described the current exchanges as a highway built years ago that can't handle rush-hour traffic and ends up disrupting lives as people are caught in traffic.

Harris noted that the Nasdaq has old technology that needs updating. He compared it to an old electrical system that seems to work OK much of the time but ends up with large power outages.

Lauer said technology will fail on occasion, but the exchanges and regulators can avert serious problems by "testing, simulations and backup planning."

Rather than a three-hour breakdown, he said, an exchange should be up and running in a few minutes. He faults regulators for failing to require these protections.

"It's incredibly disappointing," he said.

Securities and Exchange Commission Chair Mary Jo White said late Thursday that she plans to convene a meeting with exchange executives and other market players to discuss regulatory practices.

"Today's interruption in trading, while resolved before the end of the day, was nonetheless serious and should reinforce our collective commitment to addressing technological vulnerabilities of exchanges and other market participants," White said in a statement.

She added that she will also work toward finalizing rules proposed this year that aim to bolster the security and soundness of exchanges, clearing agencies and certain large privately operated, or dark pool, trading venues.

Harris noted that updating systems is expensive, and now that companies such as Nasdaq are publicly traded, there can be a conflict of interest between protecting people using the exchange and the shareholders of the company's stock.

Upgrades are difficult, he said, because they can go badly if they don't mesh correctly with old systems. But complete overhauls are expensive.

Meanwhile, Thursday's incident "is a real black eye for Nasdaq."

gmarksjarvis@tribune.com

Twitter @gailmarksjarvis

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