Friday, January 6, 2012

Ready For Another Flash Crash?

As if there aren't enough financial and geopolitical troubles on the horizon early in 2012, a new paper by David Cliff and Linda Northrop published by the Bank for International Settlements has raised the spectre of another "flash crash".  For those who don't remember, on May 6/2010 the stock market inexplicably plunged over a cliff - only to recover most of its losses about 45 minutes later.  In the meantime, almost a trillion dollars were lost by investors.  (To be precise, the Dow Jones Industrial Average lost 650 points in 30 minutes, destroying $850 billion off share values before rebounding.)  In the intervening year and a half one would expect the proper authorities to have thoroughly investigated what went wrong that day - and fixed it.  You'd be wrong.  The two teams of scientists led by the co-authors above, one on each side of the Atlantic, believe that another flash crash is not only possible - but probable.  Both teams are specialists in the socio-technical risks of financial IT systems, ie. what happens when systems interact with other systems thus proliferating into systems of systems that are inherently unpredictable.  They even co-authored a report warning of major systems failures before the May 6th flash crash.  And, they say, the next crash could be worse.  "The true nightmare scenario would have been if the crash's 650-point down spike, the trillion-dollar write-off, had occurred immediately before the market closed ... the world's financial system dodged a bullet."  If the market had not had time to recover the contagion would have spread to Asian and then European markets.  Now they believe that the number and severity of financial IT system near-misses is dangerously rising again.