Knight Capital Group's computer software went bananas on Aug. 1. The company's rogue computer—Wall Street's answer to HAL—flooded the market with spurious orders. When Mary Schapiro of the Securities and Exchange Commission refused the company's request for a mulligan that would enable it to cancel the orders, Knight suffered a loss of more than $400 million, nearly wiping out its capital.
Technology has failed Wall Street before, going far back to the 19th century. According to a congressional report, at the height of the gold panic of 1869, many of the telegraph wires that carried messages giving the current New York price of gold to various cities "were melted or burned off in the efforts of operators to keep up with the news."
Knight's debacle wasn't even the first in which computers have caused big problems on the Street. The "flash crash" of May 2010 caused the Dow Jones Industrial Average to plunge nearly 1,000 points in a few minutes when computer trading algorithms interacted badly. In that case, other computers came to the rescue, cutting off trading for a few seconds—the equivalent of slapping a hysteric across the face—and the market quickly recovered.
ONE OF THE BIGGEST TECHNOLOGY GLITCHES to affect the Street occurred in the 1960s, when it wasn't computers that caused the problems; it was the lack of them.
As the great postwar bull market continued to run its course, Wall Street's ways of doing business differed little from the ways of the late 19th century. The tape was still a paper tape spewing out from a ticker. Paper stock certificates were stored by each broker, necessitating armies of runners to move them about the Street as they were traded.
Brokerage firms had telephone clerks stationed around the perimeter of the stock-exchange floor. The clerks would write out the orders to buy or sell, which were phoned in from firm headquarters. The clerks would hand them to floor brokers, who would execute the trades and hand the clerk a confirmation, which went to the back office to be recorded.
This system worked well enough when three million shares were considered a busy day, as was the case in the 1950s. But in the '60s, volume began to rise, thanks to changes in the nature of the buyers and sellers.
Individual traders, who usually dealt in round lots of 100 shares, had been the mainstay of the Street from its earliest days. But that began to change with the rise of both pension funds and mutual funds, which dealt in blocks of 10,000 shares.
In 1961 individuals accounted for 51.4% of all trading on the New York Stock Exchange. Institutions did 26.2%, and member firms did 22.4%. Eight years later, individuals did only 33.4%, and institutions accounted for 42.4%.
THE ADVENT OF THE STAR MONEY MANAGERS, like Fred Carr of the Enterprise Fund and Gerald Tsai of Fidelity and then of his own Manhattan Fund, also drove up volume. In 1955 the average mutual fund turned over about one-sixth of its portfolio in a year. By the end of the '60s, a turnover of half the portfolio was standard.
Volume was averaging 4.4 million shares a day in 1964. Four years later the average was 13 million shares, and the volume record of Oct. 29, 1929—16 million shares—finally fell after 39 years.
This caused the glamorous brokerage side of the business to expand greatly. Wall Street brokers opened a great many new offices in the years between 1964 and 1968. The number of registered reps grew from 97,000 in 1967 to 168,000 in 1969.
But the unglamorous back offices of brokerage firms simply could not cope with the new volume. The number of failed trades began to soar; stock deliveries were often held up for weeks. Complaints to the SEC more than tripled between 1968 and 1969.
THE OLD PAPER TAPE HAD GONE electronic in 1965, and a central securities depository was finally established in 1969, but it wasn't nearly enough.
In the spring of 1968, the stock exchange was forced to close on Wednesdays so back offices could catch up on paperwork. In January 1969, the Big Board resumed five-day trading but with shortened hours. It was only in May 1970, by which time the bull market was a fading memory and volume had eased off, that normal trading hours resumed.
Firms began to acquire the computers necessary to handle the new reality. But at that time—when the microprocessor was just being developed—computers were still expensive and required highly trained personnel to handle them.
Many small firms were forced into mergers or liquidations, while even good-size firms were hard up for capital to finance the switch from paper to electrons.
It was the need for this new capital that finally forced the stock exchange to allow member firms to go public. Until then they were mostly partnerships, operating on the capital contributed by individual partners and their retained earnings, if any.
Today a vast network of interlocked computer systems allows the Street to easily handle volume 400 times as great as what overloaded the Street 40 years ago. Of course, there's a price: Every so often it's the computers that now overload the Street.
JOHN STEELE GORDON is the author, most recently, of An Empire of Wealth: The Epic History of American Economic Power.