Who’s Dumber, Machines or Politicians?

08/17/2011 2:30 pm EST

Focus: MARKETS

Tom Hudson

Former Co-Anchor and Managing Editor, Nightly Business Report

Volatility continues to advance as more and more trading decisions are made by computers, and that could have an impact if we have a market shock like the one likely if the Congressional "supercommittee" can’t work together, says Tom Hudson of the Nightly Business Report in this exclusive interview with MoneyShow.com.

I know you have watched the markets over time, and we are seeing this volatility now. What are investors and traders reacting to?

They are reacting to headline risk, they are reacting to the unknown, and in the short term they are reacting to what the market matters most, which is the last price of something.

In the long term, markets do reward innovation; they reward solid business judgment and solid risk taking. They reward a significant leadership. They also reward good business fundamentals and a growth story.

But in the short term, minute-to-minute and day-to-day—when we are talking about program trading, high frequency trading, quantitative trading, the black box idea—60-70% of volume is being traded by computers short-term, and they are reacting to simply the last price.

That means that volatility, as we have said for years, is going to more and more a fact of life and a way of life for investors. You have to be able to understand what your goals are before you even begin on the path to investing.

Have we not seen this act play out before?

It certainly seems like the summer in 2011 has some similarities to the summer of 2008. Remember, in the summer of 2008, we had just gone through the fire sale of Bear Stearns and there were rumors that more investment banks were in trouble. There were clearly rumors that the housing market was more than just cracking; it was tumbling apart very fast.

In August 2008, we saw the Federal Reserve come out, unprecedented, to give a reassuring statement after it had already met and kept interest rates solid. Because the thinking was that the economy was solid.

Less than a week later, it was out again in August 2008 saying that "we are there to provide any kind of backstop." Then, of course, Lehman Brothers happened in September of that year, and AIG happened.

There are many more differences in the summer of 2011, however. What fueled the uncertainty, the volatility, and the financial crisis and panic in 2008 was from the bottom up—it was homeowners that had borrowed too heavily, households that had spent too much money, a Wall Street that had enabled that to some degree, and regulators that had turned a blind eye to it to allow Wall Street to enable that.

What we have seen here in the summer of 2011 is the manufactured debt crisis in the United States, and the real debt crisis that is going on in the Mediterranean countries in Europe; this is a top-down debt problem, not a bottom-up like we saw in 2008.

Well, let’s compare and contrast the US and the European issues, because as you said this was a manufactured crisis here, the debt ceiling and the argument about that. Would we be able to get through the political…especially with this new committee of 12, the supercommittee, that is supposed to deal with the stuff that Congress was unable to deal with?

We are going to be in the same place during the holidays in 2011 that we were around July 4. I think that the supercommittee is an idea, a theory, and it’s probably a good one.

But in reality, these blue-ribbon panels, even if they are infused with a lot of power, have never been a successful way to legislate. We have taken 535 legislators in the US House and the Senate and boiled it down to 12; we now have fewer representatives making these decisions for a trillion and a half dollars.

Is this is a representative democracy? I think not. So whatever is going to come out of the supercommittee—assuming they can come to any kind of consensus—is likely going to hit a roadblock in the Senate and the House.

Then if they don’t come to a consensus, then we have automatic spending cuts that happen right away. So I would say brace yourselves for a pretty volatile fall, as well.

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