Stocks’ plunge is a troubling mystery

As global stock markets skidded further Friday, federal regulators were still scrambling to unravel the cause of a nearly 1,000-point midday plunge in the Dow Jones index a day earlier — an event that triggered new criticism that Wall Street trading has grown too risky and needs to be reined in.

Perhaps the most troubling aspect of the market’s nosedive was that it may have been fueled by a computer glitch, human error or trading programs run amok, and that such technical problems could continue to jeopardize the savings of millions of Americans.

“The New York Stock Exchange told me this could happen again tomorrow,” Rep. Paul Kanjorski (D-Pa.) said Friday. “If that’s the case, we’re in a very serious emergency situation.”

Markets worldwide extended their declines on Friday, with the Dow Jones industrial average falling almost 140 points despite a Labor Department report showing that employers added 290,000 jobs in April, the biggest hiring surge in four years.

The market’s downturn reflected continuing concerns over the European credit crisis and its potential to spread here. But it was also partly a hangover from the wild gyrations Thursday, when the Dow dived nearly 700 points within minutes, only to recoup much of that for a 348-point drop on the day.

Though the plunge appears to have been set off by a computer foul-up or an errant trade order, regulators and stock exchange officials were nonetheless struggling to pinpoint the exact tripwire.

“It’s troubling,” said Paul Zubulake, a senior analyst at Aite Group, a research firm. “They should be able to establish if it was an error.”

The free fall spooked individual investors such as Roxy Lopez, a Phoenix musician, who took three-quarters of her money out of the stock market in 2008 after losing tens of thousands of dollars during the bear market that took hold during the recent financial crisis.

Lopez had been preparing to boost her stock allocation but has now changed her mind.

“The irony is that I was just starting to feel comfortable again and I was just starting to buy some individual stocks again over the last two weeks or so,” she said. “But now with this, I don’t think I’ll put any more of my money in there. It’s too volatile and I just don’t trust the market.”

President Obama said government officials were looking closely into the “unusual market activity,” pausing as he touted Friday’s positive news about job growth to express concern about the impact of Wall Street’s turmoil and growing fears about Europe’s finances on the U.S. economic recovery.

“The regulatory authorities are evaluating this closely with a concern for protecting investors and preventing this from happening again,” Obama said.

The Securities and Exchange Commission and the Commodity Futures Trading Commission said they were “devoting significant resources and expertise” to determining the cause and would make their findings public.

“Thursday’s unusual trading activity included extreme volatility for a number of individual securities,” the agencies said in a joint statement. “This is inconsistent with the effective functioning of our capital markets and we will make whatever structural or other changes are needed.”

Initial criticism centered on “high-frequency trading,” in which swashbuckling traders on souped-up computers swap millions of shares a second. Critics say the computers have grown so powerful and quick that the slightest error can send the market reeling before human overseers can detect anything amiss.

Critics of high-frequency trading have been warning for more than a year that aggressive new trading strategies were dominating the market and leaving it vulnerable to a major shock.

HFT firms, as they are known, have surged in number and power in recent years, and are now believed to control up to two-thirds of U.S. stock trading volume.

The firms contend that they buy in volatile markets, when others are dumping shares. But experts say the speed and volume of their orders can put stocks at risk of uncontrolled declines — which is what occurred Thursday in a matter of minutes.

“In a panic situation, because of the speeds involved, it can exacerbate a sell-off in a short period of time,” Zubulake said. “That’s the reality.”

Even supporters acknowledged the need for some changes.

“I don’t view this as a black mark on high-frequency trading,” said Joe Gawronski, president of Rosenblatt Securities Inc., an institutional brokerage firm in New York. “It’s a good wake-up call to remind people that there are reasons to slow down the market and we should have rules to enable that.”

Kanjorski said the House capital markets subcommittee that he chairs will meet Tuesday to examine what’s become known as the “flash crash,” saying it’s unacceptable for “a technological error to spook the markets and cause panic.” He wrote to Mary Schapiro, SEC chairwoman, asking for an explanation of what the agency is doing to examine the problem and prevent it from happening again.

Schapiro has pushed the SEC to ban “flash orders,” a controversial practice in which high-frequency traders get a leg up by getting an early glimpse of incoming orders from other investors.

In a speech Thursday before the market plunge, Schapiro warned of the threat posed by new technologies on Wall Street to fairness for average investors.

“No longer do we rely on people shouting on the exchange floors to transact business. Instead, we rely on computerized trading whose speed has accelerated from seconds to milliseconds to microseconds. And for some, that isn’t fast enough,” she said. “But ... just because technology is progressing and trading platforms have proliferated — fairness must remain the underpinning of the market.”

The market turmoil, on the heels of the controversial Wall Street bailout and the recent civil charges against investment bank Goldman, Sachs & Co., could rally support for the Obama administration’s financial reform package.

The sweeping financial regulatory overhaul legislation, now being considered by the Senate, does not directly address high-frequency trading or other automated trading issues. But Sens. Ted Kaufman (D-Del.) and Mark Warner (D-Va.) want the legislation amended to direct the SEC and the Commodity Futures Trading Commission to study the incident and the broader issue of computer-driven trading.

“Markets have always had ‘fat finger’ errors and human-generated operational risks,” they said Friday in a letter to Senate Banking Committee Chairman Christopher Dodd (D-Conn.). “However, it is becoming apparent that the proliferation of competing complex computer models has the potential to magnify and exacerbate these problems in a way that damages market integrity and confidence.”

The major stock exchanges asserted that they had safeguards in place and that their computer systems functioned properly.

The New York Stock Exchange, for example, said it had slowed and then fully stopped trading in Procter & Gamble Co. for 90 seconds as the stock spiraled downward in minutes.

But during that stoppage, trading of the stock moved to the Nasdaq market and other exchanges.

Nasdaq said it had “no technology or system issues” associated with the wild trading, but said it would cancel certain trades that occurred at rock-bottom prices.

walter.hamilton@

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Times staff writers Nathan Olivarez-Giles and Tom Petruno contributed to this report.