The Irony In How Computers Took Over Securities Trading

Computer glitches are usually the villain of choice when a new problem hits the financial markets: most of the major crises since the late 1980s are attributed to them: the Long Term Capital Management crash, the Facebook IPO flop and, of course the 2008 financial crisis itself.

Recent blips - as in last week (this week is still a bit young, even for a market where certain investors are permitted an early peek) - include the Nasdaq freeze and the erroneous trades suffered by Goldman Sachs, or more to the point, its customers.

The irony, of course, is that computers were introduced to eliminate human error. Those darned humans are just so unproductively fallible that they were messing up the dawn of the new era of high volume global trading. There was a lot more money to made if these forces could be harnessed, but all those back-office clerks had trouble keeping up. And, even when more of them were imported, the problems did not decrease sufficiently to ease the minds of those who truly thought they could be masters of the universe.

So, the 'big iron' purveyors of the day: IBM, Westinghouse, Control Data, Texas Instruments et al were brought in to propose solutions. And they knew an opportunity when they saw one. In place of legions of frantic, sweaty clerks, they offered cool, ominous looking machines. No muss, no fuss. And if volume increased, why you just add a few more of them. They dont require overtime, they dont make mistakes and they dont complain. But - and there is always a 'but,' isn't there? - they do require competent humans to program them. One might even say prescient humans: people who can anticipate every issue that might arise with increasingly complex, global and high volume activity. Except, of course, that finding infallible programmers is as hard as finding infallible clerks. There are rarely simple solutions to complicated problems that do not, as some juncture, require thoughtful, time consuming intervention of people with experience and skill. Which is probably the point. JL

Stephen Mihm reports in Bloomberg:

There is a perverse irony to high-tech mishaps: When Wall Street originally embraced computers in the late 1960s, it did so in a desperate attempt to eliminate trading errors that had, by decade’s end, grown so serious they would help destroy hundreds of companies
The malfunctions that froze trading on the Nasdaq Stock Market for three hours -- just two days after options markets were roiled by mistaken trades sent by Goldman Sachs Group Inc. -- are the latest in a series of high-profile mishaps most likely triggered by errant computer programs.
The problem lay in what was known as the “back office” or “cage,” home to an army of clerks who processed trades. These workers tended to be underpaid, overworked, bored, and had few opportunities for advancement. Yet companies couldn't dispense with them because methods of transferring stock ownership remained astonishingly complicated, and were largely conducted with pen and paper. One broker described his company’s back office as resembling “a scene in a Dickens novel -- the only thing missing is the quill pen.”
According to the historian Wyatt Wells, the buying and selling of a single security might entail as many as 68 separate steps, each of which ran the risk of human error, from a misfiled document to an erroneously transcribed figure. Each error in turn generated even more paperwork, exacerbating the problem and delaying the delivery of securities.
In slack times, these problems could be fixed, and customers pacified. But as the bull market of the 1960s gained momentum, and the number of small-time investors participating in the rally multiplied, brokerages strained under what became known as the “paperwork crisis” or the “paperwork problem.” By 1968, one employee estimated that at any given time clerical errors trapped $3 billion worth of trading transactions in a paper purgatory that could take weeks or months to clear.
By the end of the decade, it seemed clear that the only way to tackle the proliferation of errors was to get rid of the paperwork. That meant replacing the humans who committed the errors in the first place with something more reliable: computers.
In 1969, two companies -- Goodbody & Co. and Hornblower & Weeks-Hemphill, Noyes -- introduced computing systems that automated key steps in the transfer of securities. Clifton Walker, who managed operations at Hornblower, made it clear why the company had made a $6 million investment in two of Control Data's third-generation 3300 mainframe computers: The paperwork crisis, he said, “is really an error crunch, not a paper crunch.” The chairman of the executive committee concurred, bragging that the “possibility of error has been almost completely eliminated by the new system.”
Hornblower’s system was known as the “ordermatic,” though more literate workers on Wall Street referred to it as “Horace.” Other companies followed suit, and within a few years, the transfer of shares became increasingly automated. Over that same period, the New York Stock Exchange wedded the newly-created Central Certificate Service (a clearinghouse for stock certificates) to a state-of-the-art computer system that helped eliminate more paperwork and further reduce errors.
Not all brokerages made the shift to computer records: Many proved inept at automating stock transfers, sinking money in pricey systems and then failing to manage the transition effectively. Other companies never managed to clean up the backlog of botched trades and the accompanying piles of paperwork. The bear market of 1969 and 1970 pushed a number of these poorly managed companies to the wall: Wells estimates that about one in six brokerages went under during these years.
Nonetheless, when the market recovered, companies with shoddy record keeping had largely disappeared, and the survivors reaped the benefits of automation. In 1976, the manager of Merrill Lynch & Co.’s order department told a visiting reporter that only a decade earlier “you’d see a file of 50,000 to 60,000 orders -- 50,000 to 60,000 pieces of paper – that we had to monitor manually. It’s all on a computer now, and we never see it.”
As paper -- and paper-pushers -- disappeared, the error rates dropped. In the succeeding decades, computers infiltrated every corner of Wall Street, becoming as commonplace as the harried scribes of old.
But all this progress has paid some perverse dividends. The computers that banished the file clerk and more recently, the trader, have become so powerful that their mistakes can lead to market meltdowns. It almost makes one nostalgic for the clerical errors that bedeviled Wall Street nearly a half century ago.