September 2012: Sanity Prevails

A lot has been postulated and written about Knight Capital’s recent fight for survival, and I’m happy to admit that for the time being at least, it appears as though the Jersey City-based market-maker is out of the woods. I use the words “for the time being at least” intentionally, given that in recent years the capital markets landscape has morphed into an almost exclusively electronic realm, presided over by omnipotent black boxes and algorithms, rendering the outcome of any fight for survival anything but a certainty.

In the immediate wake of Knight’s staggering losses, resulting from a trading algorithm executing a large quantity of orders in under an hour on August 1 instead of spread across a number of days, it appeared that the $440 million pre-tax loss would ultimately prove terminal, and that the relative newcomer to the brokerage community, founded in 1995, would be consigned to the industry’s bone yard.

Contemplating the media reports of the Knight fiasco took me back to September 16, 2008, while I was at one of sibling publication Buy-Side Technology’s industry conferences in Manhattan, the day after Lehman Brothers announced that it would file for Chapter 11 bankruptcy protection. I remember my ambivalence at the time, feeling, on the one hand, that the laws governing capitalism and survival of the fittest should be observed, while on the other, knowing intuitively that the loss of Lehman would have a deep, long-term psychological effect on not only the capital markets, but on the collective psyche of those living in the West. And while the economics aficionados on Bloomberg, CNBC and C-Span nodded sagely and hypothesized regarding the breadth and depth of the impact of Lehman’s failure, none was particularly convincing, given the unprecedented circumstances surrounding the investment bank’s demise.

This is why I was happy to learn that the cavalry, rounded up by Jefferies and Co., came to Knight’s rescue on August 5. That move, some would argue, flies in the face of capitalism, but recent history has taught us that such initiatives are the lesser of the two evils. After all, now that the dust has settled on the Lehman collapse, it has become patently obvious that when it comes to the scenario where it is touch-and-go as to whether a major financial institution will survive or not, the cure often turns out to be worse than the disease. You don’t need to look past Lehman for proof of that.