The Cost of Market Failures Is Rising

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Following only their second losing day this month, U.S. stocks are back in the black this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) up 0.12% and up 0.2%, respectively, as of 10:05 a.m. EDT.

The rate of failures is increasing
Goldman Sachs
(NYSE: GS  ) was left in the lurch when the New York Federal Reserve failed to allocate the investment bank any three-month Treasury bills in a Sept. 9 auction. Because the system through which primary dealers submit their bids didn't capture Goldman's three-month T-bill order, someone at the New York Fed entered the order manually, awarding Goldman an over-allocation of six-month Treasury bills and none of the three-month maturity in the process.

The error skewed demand in the two maturities, throwing a kink in the yields the auctions ultimately produced -- too high for the three-month bills, too low for their six-month bills. In addition, the Financial Times is reporting that Goldman suffered a loss due to the snafu. This comes only a few weeks after Goldman experienced a system malfunction that caused it to send a flurry of erroneous option orders to multiple exchanges, at a cost that is likely to be in the tens of millions of dollars.

In another story that highlights the increasing frequency -- and potential cost -- of technological failures, rating agency Standard & Poor's has warned that global exchanges are vulnerable to a credit rating downgrade due to increasing "operational risk." Although S&P has not carried out any downgrades on this basis to date, Nasdaq's (NASDAQ: NDAQ  ) recent record suggests it could be first in line. In its report, S&P noted that "Nasdaq's operational glitches, for example, could damage its franchise."

Last month, a problem with a Nasdaq data feed caused an unprecedented three-hour trading interruption, which affected some of the largest, most liquid technology names in the world, including Apple, Microsoft, and Google. Last year, the exchange also managed to botch Facebook's high-profile IPO.

Ought these failures to concern you? If you're a trader, anything that disrupts your ability to trade is a problem with potentially severe and expensive consequences. Long-term investors, on the other hand, have much less exposure to this type of problem (almost zero, in fact). That's just another reason to participate in the equity markets as an owner-investor, rather than a renter-trader.

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