Five years after the harrowing $1 trillion stock market crash (innocuously and misleadingly referred to as the “Flash Crash”) a trader is arrested, calling into question most of what has been said about how that crash happened: Five years ago next week, the stock market crashed, losing close to $1 trillion in just minutes before bouncing back up about $1 trillion. It was like a bungee jump, but with victims and not only those who lost money: public and investor confidence in the markets were the biggest victims and they haven’t recovered. This historic, but often overlooked event is a stark example of the many weaknesses in the US markets, which tens of millions of American families, businesses and our economy depend on every day. While there were a number of investigations and questionable conclusions, the cause of this crash has remained a mystery. But last week, a trader in the United Kingdom was charged with contributing to it, allegedly working from his home using slightly modified store-bought software.

To say the least, it is troubling that such a single trader could engage in an egregious years-long pattern of massive trading, reap $40 million in profits and go undetected for five years. On top of that, this is the same trader who was identified – but never investigated – by the industry self-regulatory organization (SRO) CME as engaging in illegal manipulative practices apparently on the very morning of the crash. The Wall Street Journal reported this week that, “[i]nvestigators overlooked evidence given to them just hours after the 2010 ‘flash crash’ that could have enabled them to uncover the strategies of Navinder Sarao, the trader now accused of helping cause the violent selloff in stocks that day, according to members of a committee that oversaw the investigation.”

If that isn’t enough to crush your confidence, making it all worse is that the prosecutors and regulators only caught him after a diligent whistleblower provided them with a pile of evidence against the trader. As Better Markets President and CEO Dennis Kelleher said in reaction to the arrest, there were “flashing red lights around this guy,” but he was not detected, investigated or even scrutinized. It’s clear that the multiple investigations into the crash, while undoubtedly done in good faith, have some serious deficiencies for missing the actions of this trader. After all, if this apparently relatively unsophisticated trader was not noticed, what else was missed? If you want to read what some of the most sophisticated observers and market participants have to say on this subject, read Joe Saluzzi and Sal Arnuk at Themis Trading here.

As troubling as this specific case is, it’s likely just the tip of the iceberg when it comes to the world of predatory high frequency trading. While the markets and market participants move at 21^st Century speeds of microseconds – soon to be nanoseconds – our regulators and prosecutors are still in the horse and buggy era, where it takes years to even know what is going on, never mind actually catching someone breaking the law. That’s why Better Markets has been pushing regulators and policy makers for years to aggressively enforce existing laws and enact new rules under existing authority to bring transparency and a level playing field back to our markets. It’s long past time that we act to restore the integrity of our markets and protect investors. 

AIG will go down in history as an egregiously reckless company that faced certain bankruptcy but for a $185 billion bailout from US taxpayers, which wasn’t enough for its former CEO, who is suing the US government for $40 billion more: After recklessly selling insurance called credit default swaps (CDS) and indefensibly having no reserves for any losses, AIG was de facto bankrupt in September 2008. It had two choices: file bankruptcy, which would have extinguished all equity shareholders, or accept a bailout from US taxpayers under whatever terms it chose to offer. Those were the only choices facing AIG.

Put differently, the stock of the former CEO and every other AIG shareholder would be worth zero today but for the generosity of the US government and taxpayers. Every penny above zero has been a windfall for that CEO and those shareholders. But facts like that apparently don’t mean much when you’re a billionaire like AIG’s former CEO. You just hire a good lawyer and sue the US government for more, more, more. Actually, $40 billion more. And, when you’re a billionaire, just because one very highly-respected judge throws out your lawsuit with a detailed, well-reasoned 89 page opinion, you just have your lawyer file the case in another court. That is one of the reasons why Better Markets President and CEO Dennis Kelleher told the New York Times that those who brought this lawsuit “got lucky with a judge who decided he wanted to listen to a claim that should have been laughed out of court.”

Before trial, most commentators and pundits viewed the suit as meritless. However, with the trial now over and with closing arguments completed last week, a number of commentators now think the case might not be frivolous. Why? Because former government officials like former Federal Reserve Chairman Ben Bernanke and former Treasury Secretary Tim Geithner didn’t have prefect recall of events more than six years ago. Moreover, there were different views by different people in government at the time about some of the key events and actions, which were reflected in emails introduced at trial. That all these events happened during the biggest financial crash since 1929 based on extremely incomplete information and very fast moving events within an overall context of total ambiguity seems to have been lost at trial and on this judge. It was literally a race to prevent events from overtaking decision makers who were trying to prevent a total collapse of the financial system and a second Great Depression. 

No one seems to remember that – just one week before AIG blew up – no one had any idea that AIG had such massive destabilizing exposures to the financial system or that these CDS time bombs were invisibly embedded in an interconnected web of systemically significant financial firms. Or, that the AIG blow up happened just hours after Lehman Brothers filed for bankruptcy, which unexpectedly and very quickly caused the financial system to freeze and slip precariously close to the edge of total collapse. One unanticipated event happened after another, on a daily basis, as completely unexpected threats emerged from the fog of financial contagion.

That senior policy makers cannot remember even key events with precision six years later is to be expected. That government officials at the time hotly debated and disagreed about what to do and what authority they had under such unprecedented fluid circumstances is also to be expected, particularly given that the facts were constantly changing and new information was coming in virtually nonstop. We at Better Markets have been very critical of some of these actions, especially the terms and conditions of the bailouts, not to mention a number of the particular actions and decisions of Geithner and Bernanke. 

But it is nevertheless a perversion of justice for the former CEO of AIG to sue for more money. It is victimizing the American people three times: first they had to fund the bailouts (and bonuses awarded after the bailouts to some of the very people at AIG who recklessly blew up the company); second, they suffered from the economic calamity caused by AIG and the rest of Wall Street; and, now third, they have had to defend this case and are supposed to pay AIG’s former CEO and shareholders another $40 billion.

Frankly, the government should have countersued to recover the windfall the former AIG CEO and the other shareholders received and distributed the proceeds to the tens of millions of Americans who have suffered from the financial crash and the economic wreckage it caused. A decision by the judge is expected later this year and, regardless of the ruling, an appeal is expected.

Must-watch presentation from Edward Kane, a leading voice in the fight for financial reform: Edward Kane, a professor of finance at Boston College and respected author of numerous books and agenda-setting papers, has been a leading voice in the fight for financial reform. His background as a founding member of the Shadow Financial Regulatory Committee and a senior fellow in the Federal Deposit Insurance Corporation’s Center for Financial Research, among other important positions, has given him a unique perspective into our financial system and the urgent need for reforms. He’s highlighted the weak links in our economy, from shadow banking to systemic risk, and discussed the state of our markets following passage of Dodd-Frank financial reform.  

At the  Institute of New Economic Thinking‘s (INET) recent conference at the OECD in Paris, France titled, “Liberté, Égalité, Fragilité: New Economic Thinking 2015,” Professor Kane presented a summary slide show of a terrific paper, “Unpacking and Reorienting Executive Subcultures of Modern Finance.” The slide show, with cartoons (as is his MO), can be seen here and the entire paper can read here. He did this as part of a must-watch panel presentation  titled, “Financial Regulation That Might Have a Chance of Working,” along with Chair of the OECD EDRC William White, Financial Times columnist John Kay, former Fed official Walker Todd, venture capitalist and author William Janeway and Iceland Professor Gudrun Johnsen. You can watch a video of the entire panel discussion here. His website is here.   

And don’t miss the upcoming conference in Washington, hosted by INET and an independent committee that includes Anat Admati of Stanford University, Ceyla Pazarbasioglu of the International Monetary Fund, Gudrun Johnsen from the University of Iceland and Signe Krogstrup of the Swiss National Bank, that will highlight the role of finance in society. Speakers include Senator Elizabeth Warren, Federal Reserve Chairwoman Janet Yellen, and IMF Managing Director Christine Lagarde. To learn more about and register for the conference, click here.

Better Markets in the News: 

The Old New Financial Risk: Project Syndicate by Simon Johnson 4/28/2015

The ‘Flash Crash’ Guy is Not the Problem: MarketWatch by David Weidner 4/23/2015

A.I.G. Bailout Lawsuit Trial Ends as It Began, With Most Issues in Dispute: The New York Times by Aaron M. Kessler 4/22/2018

What the BNY Mellon Forex Settlement Really Means for SWFs: Sovereign Weatlh Center by Loch Anderson 4/23/2018

CME Faces Scrutiny Over Warning Signs on ‘Flash Crash Trader’:  Financial Times by Kara Scannel, Nicole Bullock, and Gregory Meyer 4/23/2018

News You Don’t Want to Miss: 

Crash Boys: Bloomberg by Michael Lewis 4/24/2015

Economists Still Think Economics Is the Best: The Atlantic by Moises Naim 4/14/2015

Big Banks’ Debt-Cost Conundrum: The Wall Street Journal by John Carney 4/28/2015