Originally published May 25, 2010 at 10:58 AM | Page modified May 25, 2010 at 11:13 AM
Written by Jon Talton

Sound Economy:What's causing stock market volatility

Beyond primal greed and fear, the movements of the stock market are often a mystery, whatever comic-book explanation may be given by commentators in the moment. The real causes are usually cloaked by millions of individual investor decisions.


Beyond primal greed and fear, the movements of the stock market are often a mystery, whatever comic-book explanation may be given by commentators in the moment. The real causes are usually cloaked by millions of individual investor decisions.

With Tuesday's swoon on Wall Street, following a worldwide sell-off and days of volatility, fear is definitely in command. What else? Lets run through the suspects.

• North Korea. Definitely. The rogue nation is the crazy uncle in the attic, armed with at least rudimentary nuclear weapons and apparently locked in a power struggle as Kim Jong-il fades. Anything could happen. Worse, this unpredictable and dangerous state is located in the heart of the rising world economy.

• European sovereign debt. Not exactly. Europe has long had what Americans would consider lavish welfare states, big government, outlandishly superb infrastructure, etc. The issue is more complicated. First, the euro is a currency experiment that may not survive the Great Disruption — it's a common monetary policy without a common fiscal or political system. Weak nations (Greece) have the potential to drag down strong ones (Germany). Many investors diversified into the euro and now regret it. Second, the exposure of major banks to complex, opaque bets made on the debt could become subprime redux. Some players are no doubt driving down the euro by profitably betting against it. The global financial system's hyper-interconnectivity is once again akin to the malevolent Skynet in the Terminator movies.

• Flash trading: Yes. The so-called flash crash of May 6, caused or worsened by the computerized trading operation, is still spooking markets. Regulators still don't know the extent of flash trading's role, adding to uncertainty. The Securities and Exchange Commission is investigating whether market makers backed away during the crash, eliminating a crucial backstop to a market plunge. Is this yet another way casino capitalism is pulling swindles?

• Financial reform. Nah. The pending bills have been so watered down that Wall Street has little to fear, which means average Americans have much over which to fret. The too-big-to-fail banks remain. Derivatives rules have been fatally weakened. The shadow banking system, the little-regulated laboratory of crashes and fraud, remains in the shadows. A new Glass-Steagall Act to separate risky investment banking from taxpayer-insured commercial banking was dead on arrival. None of this is to say the big Wall Street institutions wouldn't use the market decline to demonize any attempt at enacting new rules.

• Leverage. Oh, yeah. Unlike classic downs in the business cycle, the Great Recession failed to clean up most of the imbalances that helped cause it. This is especially true of heavy debt loads. Australia is now facing a housing collapse fed by debt that is spreading to its banking system. Sound familiar? America's private and corporate debt loads remain very high by historical standards.

• Rally fatigue. Yes. The fuel for the past year's market rise is largely spent. This includes the hot money using dollars and cheap credit to buy equities, low interest rates, bargain stocks, and the bailout and stimulus. Now the market is overvalued and the real economy is recovering too slowly.

The result: We're uncomfortably close to a double-dip recession. Meanwhile, many average Americans burned in the stock market during the 2000s, might be asking themselves why they rushed back to the casino. Those in deficit panic attack might consider where the world still sees a safe haven: U.S. Treasury securities.