The "Flash Crash" & Market Liquidity

Tuesday's Wall Street Journal featured an article comparing the recent "flash crash" to what it termed "a real one in 1987."

Surprise, we're flirting with another such day today.

A key paragraph in the long piece read,

"Selling pressure became on both days became so intense that any remaining buyers were overwhelmed, creating an "air pocket" in stocks and other securities that led to vertiginous declines.

Many market makers on Black Monday had exhausted their funds, while others were overwhelmed by the volatility. The NYSE later took steps to boost traders' capital."

Here's my question.

It's been 33 years since the 1987 crash. We knew then that small market makers on the NYSE were incapable of withstanding the avalanche of sell orders that what was then advanced technology allowed to occur. Technology has moved on and now dwarfed the volume of that crash.

One of the significant results of that crash was the acquisition of many market makers by larger brokers, as so many of the former had shown themselves either unable or unwilling to fulfill the role, in exchange for which they were given monopolies on trading selected issues.

Why have we not yet decided, once and for all, to either let the chips fall where they may in the rare, but inevitable market free-falls, or to halt trading entirely?

It's not like we haven't had three decades and change to reflect on this important question, is it?

Markets need to be continuous, liquid and able to prevent any one buyer or seller from having pricing power over an issue. If any one of these conditions is violated, it's no longer a market.

Period.

Maybe the problem is that the industry hasn't given Congress a sensible, practical approach to what are well-known conditions.

In 1987, there were 2-3 similar 'gapped pricing' upward spirals earlier in the year. But, because fills resulted in higher prices, nobody complained. It was a different story in October of that year, when equity sell orders got filled at prices far lower than the quotes at the time of the market order placement.

We know how equity markets behave in these situations. Simply put, market makers won't step in to catch the "falling knife" of plummeting prices on equities. They will not answer phones, and will institute "speed bumps," in hopes that a pause of 1-2 minutes will fix everything. So, in that situation, it's an implicit closure of markets.

If, instead, as over on the NASDAQ, market sell orders continue to flood a market with no buyers, prices will plummet. If anyone still wishes to enter market orders in that situation, it's buyer beware.

Which do we want to exist in observable situations of market panic, as characterized by trading volumes and index price declines/unit of time?

We need our sector executives, especially on the exchanges, to formulate workable solutions and insist that Congress enact them so that all investors know, a priori, how markets will, or will not, function at times in which pre-defined crisis parameters apply.