“The truth may instead be that the finance industry not only has fewer missteps than the rest of corporate America, but that sometimes failure is a good thing.”

-Steven M. Davidoff



Just what we needed, another silly article defending yet another Wall St. failure.

Following Knight Capital’s $400 million dollar computer trading error, there was a bizarre article in the NYT’s Dealbook earlier this week. It tried to make the case that Wall Street’s occasional snafus are really no big deal. I want to clarify a point on Knight, and then explain why this Dealbook article is so ridiculous.

First, about that Knight Capital snafu. They tried to bring a new computer trading technology online, they failed (miserably) to adequately test it and/or anticipate a variety of potential errors. It cost them nearly half a billion dollars. Their stock (KCG) plummeted 74%. The firm required a lifeline from outside investors, and numerous people were — or will be — sacked.

I have precisely zero problems with this scenario.

A company, as happens quite often, screwed up royally. They were not bailed out by taxpayers, their losses were not externalized to third parties. The people responsible for the errors were not given a free pass, the global economy was not driven to collapse. No laws were broken. No new regulations were required to respond to this. There will not be Congressional hearings on this issue. All told, exactly what was supposed to happen happened.

I wish more of our financial cock-ups looked like this one.

And therein lies the absurdity of the NYT article. What should be a typical case of a major brokerage/banking error is notable because it is the exception – not the rule. This is how companies are supposed to fail. They do something wrong, they pay the price, and they either go out of business, or bought on the cheap or broken up for parts.

But what the author failed to recognize is what makes the finance sector different from all other sectors: The impact it has on the rest of the economy. When Research in Motion or Sears messes up, well its bad for RIMM and SHLD. Even Microsoft’s lost decade has only hurt Mister Softee and their shareholders and users — not the entire global technology infrastructure.

When AIG or Citigroup or Lehman Brothers or Bank of America or Bear Stearns or Long-Term Capital Management mess up, it is not an exaggeration to say it threatens the global economy. Look at the damage MF Global caused versus the collapse of WorldCom. Or Refco versus Tyco. The list goes on and on.

There are numerous reasons for this distinction, but consider these three:

1. Credit Issuance: Credit has become the lifeblood of the global economy. When these firms slow or stop issuing credit due to their errors, it has a major impact on economic activity. Yes, companies are too dependent on short term credit, but that is the environment bankers helped create — they must be cognizant of the impact they have.

2. Leverage: Beyond credit, no other industry uses so much leverage to achieve profitability. Other sectors throttle back during slow downs, but Bankers ramp up from 8X to 40X to maintain profitability because they can. When they slip up, they crash and burn, rather than merely stumble.

3. Fiduciary: Many financial institutions have (or appear to have) a fiduciary obligation to clients. When they betray that trust, it appears to be far worse a violation than merely missing a quarter.

This was the genius of Glass Steagall. When bankers had their all-too-regular implosions, they did not spill over onto Main Street. Just look at the impact of the 1987 market crash on the real economy — it was de minimus.

We shouldn’t have to jump up and down and cheer “Yeah! A Wall Street company screwed up, and the rest of the world did not implode.” That should be our default setting. That its not tells you all you need to know about what is wrong with our financial system.



In $440 Million Trading Error, Upside of Wall St. Failures
NYT, August 7, 2012


Category: Bailouts, Corporate Management, Credit, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

11 Responses to “Upside of Wall St. Failures? Nothing”

  1. Moss says:

    Ridiculous indeed. The software snafu by Knight was a case of poor quality control. They did not even know that a testing component was actually in a live production environment. A simple thing like version control would prevent this. The financial system like anything with numerous dependencies is only as strong as its weakest link. Thus when AIG, or Lehman or LTCM blew up the whole system was at risk.

  2. Chief Tomahawk says:

    Hey, I hear business in the Hamptons (summer rentals and the like) are down. Impending contraction in the vaunted financial sector is being blamed.

    Are we going to get a Hampton scouting report anytime soon? There could be some sales about to entice such a visit…

  3. Jim67545 says:

    When one company of a type of business blows up suddenly and in an unexpected way, its lenders not only focus on that business but question and perhaps adjust their risk beliefs on all loan customers in that industry. How many other customers in X industry have this same here-to-for unknown risk element? (Example: GM terminating Hummer, Saturn, etc. dealerships) Ordinarily that is not a biggie but it could cause a brief pause in new credit extensions. (Example: freeze in lending to Chevrolet dealers while GM was deciding who would survive and who would lose their franchise.)

    The smaller the lender’s exposure to the industry and if they conclude the blow-up is a one-of, then things settle back to normal. However, if the total exposure is huge (such as AIG or Countrywide) and if the business is close to the center of money flow (such as Lehman or Morgan Stanley) then things freeze up across multiple flows of funds as the Lender’s confidence in their knowledge of level of risk is replaced with fear of the unknown.

    It’s like the difference between having a blood clot in your finger versus in your aorta. So, in addition to BR’s observations, the reaction is also dependent on others’ lending behavior as a result. I think this explains the difference between this situation and what happened to the TBTFs.

  4. Northeaster says:

    “Following Knight Capital’s $400 million dollar computer trading error” -

    Much like “Calculated Risk” puts charts up of data, Nanex of course has been following this for some time with their own charts:


    Of course, HFT’s are supposed to provide liquidity right? I can’t compete with that, and neither could my broker, I’ll keep my cash thanks.

  5. dcsoswordpress says:

    But what about all the trades not cancelled (RIGHT FULLY ON THE KNOGHT SIDE)
    that trapped investors who had stops in the market that were falsely triggered
    by the flash crash nature of KNIGHT’s OWN MISTAKES?!
    it took down honest investors whose strategies were unfairly triggered by KNIGHT’s UNLAWFULNESS.

  6. BITFU Search Engine says:

    After reading Barry’s post, I did a Left vs Right search on Glass-Steagall.

    Here’s a short article from Cato-Intitute, which offers a decent perspective from the Right criticizing “the religious-like devotion expressed by proponents of Glass-Steagall.”


    I admit, upon the first reading of the Cato post, I found it persuasive. [But I'm not too bright. Seriously, as I write this, I'm donning at baseball cap purchased from a stripper at the Cheetah...for $50. I sh*t you not. And what's more, "Mercedes" (that's her real name. I just know it.) offered to throw in a T-shirt for an extra $25.00 and I actually thought I was being "prudent" and "disciplined" by refraining! Sure I was drunk, but so what? I'm not drunk now, and yet...

    I'm wearing a loser, dunce-cap with a glossy, gold-scripted "Cheetah" emblazoned on the front...on a FRIDAY MORNING, no less...so yeah...I'm not too bright.]

    Anyways…when the Cato author writes that

    Bear Stearns, Lehman Brothers, Goldman Sachs, and Merrill Lynch were all stand-alone investment banks. They didn’t take deposits. And of course, Fannie and Freddie weren’t even banks. I have yet to hear a good explanation of how Glass-Steagall would have prevented trouble at these institutions. And those banks that did combine investment and commercial activities, like Wachovia, WaMu, and Citibank, got into trouble because of their mortgage portfolios.

    That brings us to the bizarre implicit assumption behind Glass-Steagall: that somehow commercial banking is risk free. Anyone ever hear of the savings-and-loan crisis of the late 1980s and early 1990s? No investment banking angle there. How about the 400+ small and medium banks that failed in the recent crisis? According to the FDIC, not one of them was brought down by proprietary trading.

    He conveniently avoids the fact that the repeal of Glass-Steagall dramatically increases the chance that a financial firm will become TBTF. The failure of the mortgage portfolios of C should have brought this firm down…but it survived b/c of TBTF. Even I can figure this out.

    Now that I’m done with this interminable post, maybe I’ll go and set-up an online T-shirt store with a target market of dumbasses all to eager to impress…you know the kind of doofus who actually buys baseball caps from strippers. On the front of each shirt will be the simple, yet all too descriptive acronym:


  7. [...] Knight Capital ($KCG) as a model Wall Street failure.  (Big Picture) [...]

  8. bear_in_mind says:

    As “Northeaster” attests, there’s second-order effects on investor trust and psychology that accrue from these kind of egregious events which are harder to measure but don’t bode well for the overall health of financial markets.

    It’s stupefying that Wall Street’s titans cannot see how their destroying the industry, but I suspect they have so much of the assets belonging to the Top .01 percent that they’re well-insulated from popular reality. They’re still making ‘bank’ because the BIG MONEY goes where they’re going to make the best returns.

    Wall Street has yet to drive off the BIG MONEY, but as reckless as they’re becoming, they risk scaring off the whales. Now, that is the fracture that will likely, finally, bring Wall Street to its knees. Could be a decade away, but given the degree of hubris we’re seeing, it’s probably coming sooner than later.

  9. ravenchris says:

    You will not find real justice while career politicians are the referees.

  10. philipat says:

    There is still an enormous rearguard action against the re-instatement of Glass-Steagall eminating, of course, from Wall Street and supported, unless there is a huge public outcry, by their part-time employees in Congress.
    It just seems like good old common sense that the casino banking operations contribute nothing to society and yet the potential for enormous losses depositors and taxpayers at risk. IMHO all iBanks should be private unlisted operations where the capital of the principals and other knowing investors is deployed. If they win big, fine. If they lose big, they fail and nobody other than the private capital holders suffers.

    Publicly-funded elections, term limits for Congress, restrictions on revolving doors and strict restrictions on lobbying activities would also help.

    The present US system is horribly corrupt and totally broken and I truly don’t see how the US can move forward until the system gets fixed. The self-righteousness, which still remains, does not help and, in fact is a typical manifestation of all fascist and totalitarian States.

  11. rd says:

    The big difference between the financial sector and regular companies is leverage. Most companies borrow money for long-term capital projects with real costs and real returns. The bonds need to be amortized over years, so it is difficult to have too much debt compared to revenue because the interest payments alone consume the company. Debt of 50 to 100 times the assets of an industrial company would be very difficult to pull off, but it seems to be normal in the ifnancial sector.

    A financial company can go from being “stable” to a basket case in a matter of days due to the sudden addition of short-term leverage that they can accomplish as in Knight’s case. An industrial company generally can’t get into this type of sate without months or years of warning.