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NewsNotables – Issue 62

In the last Ethix issue (61), we commented on rumors about Lehman (now in bankruptcy) that drastically fluctuated their stock price. In September a similar situation developed due to Internet technology.

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How Google Mix-Up Caused $1 Billion Run on United

Times Online, September 12, 2008

The SEC has opened a “preliminary inquiry” into how an outdated bankruptcy story sparked a $1 billion run on United Airline’s stock value. On September 8, 2008, an article about United’s bankruptcy filing in 2002 was revived when it showed up on a newspaper site’s “most viewed” section. It was picked up by Google News and alarmed stockholders and investors. United stock plunged from about $12 to $3 a share before trading was halted.

The errors provide a salutary lesson for investors of the power and perils of computer automation and throw a spotlight on Google’s News technology which, using “Googlebot” algorithms, scours web pages in search of news articles. The comedy of errors began with just one reader who went to the South Florida Sun Sentinel’s website and viewed a 2002 article on United Airlines’ bankruptcy.

That single visit early Sunday morning, a period of low traffic, apparently bumped it into “Popular Stories” in the business section. At 1:37 a.m., an electronic Google program swept through the paper’s website for new stories and spotted the link. A Florida investment firm found the story on Monday morning with Google search and posted a summary on the Bloomberg financial information service. Bloomberg is seen by thousands and sparked the run on United shares.

Experts said the automated trading programs were applied to the trading of shares based on market moving information and algorithms again played their part. Last year, algorithms handled some 30 percent of all equity trading volume and is projected to increase to 50 percent by 2010, according to a recent study by Aite Group.

Comment: The episode is a reminder that computer programs, no matter how sophisticated, can be a poor substitute for human beings. Investors lack of confidence in the troubled U.S. airline industry undoubtedly played a part in the stock drop. United filed for bankruptcy in 2002 where many investors, including me, found their United stock worthless. Many investors mistakenly figured United might be filing for bankruptcy once again.

Keep it in Vegas

The New York Times, September 17, 2008

“Watching some financial stocks just get wiped out in recent months, I often hear a voice in the back of my head, and it is the same voice as one of those dealers in Las Vegas who coolly tells you as he sweeps up your chips after you’ve busted in blackjack: ‘Thank you for playing, ladies and gentlemen.’”

That’s what happens when the bubbles burst in the stock market, you feel wiped out and the coolness with which the dealers, in this case the markets, sweep away the chips is unnerving. What happened here is the financial industry became a bubble in recent years thanks to an excess of liquidity and the oldest bubble maker in history: “greed.”

In the ’90s, the no-lose, risk-free, high-yield return was supposed to be the dot-com stocks. This decade’s version are the subprime mortgages and financial stocks. Just like the dot-comers in the 1990s, the financial stocks got inflated to ridiculous levels and salaries for Wall Street executives reached stratospheric levels. We are now watching that bubble burst. Who would have believed that the 158-year-old Lehman Brothers would file for bankruptcy?

We need to know the uniqueness of this bubble in order to identify the government’s role. Many people were able to became homeowners getting subprime mortgages, who wouldn’t have qualified in a sane market. Finance companies and banks, which extended those mortgages, later resold them to an aggregator who put them into large packages with thousands of other subprime mortgages. Then these loan packages were chopped up and sold in small pieces as corporate bonds to institutions and individuals who were reaching for extra yield.

As the housing market collapsed and people couldn’t pay their mortgages or sell their homes, the bonds lost value, the banks that held them lost capital, and the whole pyramid started to crumble. This infected the entire housing market and banks no longer knew the value of their mortgaged-backed assets and curtailed lending. Hence, the current credit crunch.

Comment: It’s easy to overreact and important that we don’t. Now is the time to calmly sort out what markets can do best and what governments need to do better. Some of the smartest people forgot one of the oldest rules — there is no such thing as a risk-free return. When you reach too far for yield, sooner or later you get burned. Government’s job is to police that fine line between the necessary risk-taking that drives an innovative economy and gambling with other people’s savings in ways that threaten us all.

Much has happened since this article was written. As I write these comments, the Dow Jones Industrial Average capped the worst week in its 112-year history with its most volatile day ever swinging 1,019 from the bottom to the top. The market was overwhelmed with hopes for an international bank rescue plan. The tumultuous economy is now global and it will take efforts worldwide to bring back normalcy, however we define it.

By Roger Eigsti
Board President,
Institute for Business, Technology, and Ethics

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