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On May 6, 2010, the stock market suddenly swung a thousand points
On May 6, 2010, the stock market suddenly swung a thousand points. Nobody really knows why. But Dennis Berman, in the Wall Street Journal, has a clue: Maybe the regulators did it. He notes that it results from 1975 market reforms aimed at eliminating market makers who were increasing trading costs by increasing spreads. "By the time the last big market reforms were issued in 2005, the intent was to give investors, particularly retail investors, greater confidence that they will be treated fairly," the SEC said at the time. But now those greedy market makers have been replaced by machines, leaving nobody with the responsibility to step in at a time of distress like the flash crash.
So according to Berman, "We have traded cheaper up-front costs for unknown back-end ones. That is exactly what is spooking the same investors the SEC vowed to protect in 2005.""Congress is now thinking of fixing this system, apparently suggesting that maybe investors are not, in the words of Delaware's Senator Kaufman, 'best served by narrow spreads'."" And we'll undoubtedly get a regulatory fix, perhaps in the form of the Dodd-Frank bill enacted in 2010." "But will additional regulations solve matters?" Berman quotes Vanderbilt's William Christie: "It's kind of like a balloon, you squish one side and it pops out the other."
Comprehension Questions:
1. Could it be possible that a government regulation led to the flash crash? Explain.
2. What does it mean - 'it's like a balloon'? What is like a balloon? Why is it like a balloon?
3. Explain why government regulations to restrict some activity occurring in a free market typically end up making matters worse.
4. Who supported the Dodd-Frank bill? Who opposed it?
Expert Solution
1. As we know that flash cash means that a deep, rapid, and volatile fall security prices occurring within an extremely short period. The main reason for flash cash is an inconsistent way of dealing with bad prices, stock exchange fluctuations, etc. Here we find that government regulation will lead to flash cash. That is the government can create functions and restrictions. That is the government can create and implement policies that will impact the business to increase its own securities.
2. Here the author can use the proverbs " it's like a balloon". We know that balloon is blown up and squeezed another side, then the other side is also popping out. Here the author pointed out that the government regulations when a government can protect the public from economic failure will decrease the risk in our financial system. It is like a balloon. when a law is enacted in the economy that will lead to creating new laws in the economy.
3. In this study, the author pointed out that business is affected in many ways, that is when the government organizes the tax rate, then it lessens the bottom of the organization. In real sense, the government is the biggest player in the economy. So no one can affect the market. Now when a market is considered to be the free market then, there is nothing will impact anyone's action in the economy. And people easily can afford what they needed.
Here the government activity will restrict some fluctuations in the free market. That prevents the reduced output, free entry, etc. Continuous regulations and rules will always benefit to the business.
4. As we know that the Dodd-Frank bill or the consumer protection act is federal law, It creates a most significant change in the financial market. It made changes in the US financial environment that will affect the US financial agencies. The law is criticized in various ways. Someone said that it is not the right law to prevent another financial crisis. But someone said that it is the right law at the time of the financial crisis.
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