By Heidi N. Moore
July 1, 2010

The new plan to stop runaway stocks works, and it works well.  Now to figure out what makes them freak out in the first place.

By Heidi N. Moore, contributor

Imagine this: in a world much like our own, a problem in the markets prompted a Congressional hearing that led to quick action by a major player in the financial markets. The fix worked immediately and prevented further trouble. No year-long studies were commissioned.

In these times, when the economy is all breadlines and Politburos, this tale sounds like something from a fantasy book – say, Bedtime Stories for Capitalists. It did, however, really happen. And, yesterday, it helped save Citigroup (C) stock from a pretty bad massacre, helping the bank’s stock drop only 5% for the day rather than the 12.7% drop that could have been implied by a single trade that the New York Stock Exchange ultimately canceled. Citigroup’s stock was trading at around $3.80 when the order came in for $3.31 a share.

This is of course the incredible true story of the New York Stock Exchange’s quick move to put in circuit breakers to prevent more flash crash mayhem like the dark day of May 6. Yes, the circuit breakers were delayed at first — the SEC had to approve them — but since then they’ve earned their keep. Two weeks ago, the circuit breakers kicked in for the first time when Washington Post Co. (WPO) shares more than doubled within an instant to $919.18 from $460. That movement was also ascribed to an erroneous trade, and the trades were canceled, according to exchange officials.

Just as importantly, even when the circuit breakers aren’t on, they’re working because officials are paying attention. According to the New York Times, shares of Boeing (BA) suddenly dropped to $38.77 from $68.77 on Monday, a mistaken trade that officials at two exchanges later expunged without stopping trading.

The New York Stock Exchange deserves kudos for listening to criticism and then doing something about it. The circuit breakers appear to be a successful way to prevent market glitches from metastasizing into full-blown panics.

It is admirable that the NYSE knows how to stop the glitches from becoming disasters, but the success of the circuit breakers may be a distraction from one thing: We still have no knowledge of what really caused the May 6 flash crash, and we’re equally ignorant about what caused subsequent issues with the Washington Post and Boeing stock. In fact, considering the flash crash and the two subsequent stock incidents, it appears that erroneous trades are becoming more common. Either there’s something wrong with the exchanges’ software offerings, or there are genuine trends about trading partners and market structure that need to be understood and explored. This might actually be one of the few situations where we really could use a long study.

–Heidi Moore is Sweeping the Street for the two weeks that Colin Barr is on vacation.

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