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Breakingviews

‘Flash Crash’ Case Suggests Small Problems Can Cause Systemic Issues

The flash crash of 2010 resurfaced with an arrest on Tuesday. Prosecutors at the Department of Justice along with the Commodity Futures Trading Commission have accused one self-employed trader in Britain of manipulating futures markets so much that he played a significant role in the events that led to the five-minute, 1,000-point plunge in the Dow Jones industrial average on May 6, 2010.

It’s a fantastic-sounding tale. The lawsuit, however, which focuses on 12 days in 2010, 2011 and 2014, asserts that Navinder Singh Sarao at times accounted for 40 percent of order activity on the E-Mini S&P 500 futures at the Chicago Mercantile Exchange.

His plan of attack, according to the allegations, was to put multiple orders in the system just off the best price to create enough volatility to foster artificial prices. He would then pounce on the dislocation, canceling 99 percent of his previous orders in the process. If true, it’s a timely reminder of the limits of regulating risk.

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A display at the New York Exchange shows the precipitous 15-minute tumble of the “flash crash” in May 2010.Credit...Lucas Jackson/Reuters

It’s not unusual for a handful of people, or even just one person, to rack up big losses or incite a problem in the markets. JPMorgan’s $6 billion “whale trade” loss was one. So was Morgan Stanley’s wrongheaded 2007 hedge on an otherwise profitable subprime mortgage bet that cost the firm upward of $9 billion. Traders in both instances, though, were employed by big banks with loads of capital and lumbering bureaucracies.

In the latest case, just one person working alone helped stir a crisis. Although Mr. Sarao has been arrested, the situation leaves several questions unanswered – not least of which is why it took regulators and investigators so long to discover and prosecute a man who appears to have had little problem accounting for such a large share of an exchange-traded market.

Mr. Sarao has been arrested by British authorities, and the United States has asked for his extradition. Unlike so many others involved in the financial crisis, he is likely to be headed to court, although he indicated on Wednesday that he would seek to fight the extradition.

Until more details emerge, investors and lawmakers will have time to ponder the broader implications. So much time and rule-making has been devoted to preventing the world’s largest institutions from becoming systemic risks. This case suggests that even the smallest players can do the same.

Antony Currie is an associate editor at Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.

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