Corporate & Securities Law

Margin Calls, Human Error To Blame For May 6 Crash?

By Steven Caruso

Margins calls? Human error? Whatever the reason, billions and billions of dollars in capital vanished in the blink of an eye on May 6, the day the Dow Jones Industrial Average witnessed nearly a 1,000-point drop. Individual and institutional investors alike felt the pain - and will for some time to come. For those needing further proof of the repercussions, just look at your next 401k or brokerage statement. The losses rendered from May 6 will be poignantly clear.

Many are blaming the market?s crash on the debt crisis in Greece. Others point the finger at high-frequency trading. And some fault human error. Specifically, a number of people contend that the crash was tied to someone hitting ?B? instead of ?M? on the keyboard, resulting in a billion shares of a certain investment sold instead of a million. Various news sources have reported that the firm behind the trading error is Citigroup. Citigroup denies the claims.

Other analysts believe stocks plummeted on May 6 because of massive forced selling by big hedge funds that were responding to margin calls. Margin calls happen when people borrow heavily against their assets and then see their value plummet drastically. This, in turn, forces them to sell part of their holdings in order to make good with their lenders. The end result affects not only individual investors or institutional investors like hedge funds but also the entire economy.

Federal regulations limit the amount of margin trading that individual investors can conduct. This isn?t the case, however, with hedge funds, which are essentially unregulated and can typically borrow many times over the real value of their assets.

Regulators continue to review the financial free-fall that occurred on May 6. Regardless of what they determine, the end result will be the same: Investors are going to feel considerable financial pain for a long time to come.

Full post as published by Representing Investors on May 17, 2010 (boomark / email).