Friday, May 7

What the heck happened yesterday?

The financial crisis of 2008 and 2009 was bad, but in some ways I think what happened yesterday was scarier.

In case you missed it, the Dow Jones index plunged about 10% in about five minutes. "About $700 billion of U.S. stock- market value was wiped out in less than 10 minutes," Businessweek reported. $700 billion. That's $1.2 million dollars down the drain every second. The Wall Street Journal reported that shares of companies worth billions of dollars earlier in the day were trading at one cent, while shares of Sotheby's briefly jumped from $35 to $100,000.

Yes, the markets recovered somewhat after the free fall, and yes, the financial crisis of 2008 and 2009 had much more serious, longer-term consequences. But the financial crisis is, to a large extent, explainable. A housing bubble burst. Banks lent millions to people who had terrible credit because of faulty government incentives. The bad loans were packaged into crazy bundles that investors failed to closely scrutinize. But what was the explanation for yesterday's free fall?

It hasn't even been 24 hours, so maybe it's premature to say it's inexplicable. But nobody seems to agree how the 10 minutes of terror happened. The Toronto Star says it was probably Greece's fault. The Associated Press speculates someone might have typed in a trade for $16 billion when they actually meant $16 million. Businessweek suggests it was just plain panic selling.

Stock markets are a fundamental economic institution. They are a place where people can go to buy and sell ownership of major companies. Stock trading should be straightforward. But when company values plummet $700 billion in ten minutes and no one knows why, that's scary. A simple typographical error shouldn't be able to wreak so much havoc on financial markets.

Consumer confidence is fragile. Cracking it is how recessions can get started. And if our stock markets can lose $700 billion in 10 minutes without us having any idea why, we could be in for some very tough times.