Flash crashes in the FX market are a bug in an otherwise pretty efficient market making system, Bloomberg View’s Matt Levine writes. Levine, in the light of the GBP’s sudden plunge against the greenback, grants us another nugget of wisdom in explaining the rationale behind the current computer-based market-making system that allowed the value of the GBP to drop rapidly instead of forcing market participants to buy “all the way down to the new level” and then brought it all the way up to the new level. “Traditionally the way a drop like that would happen is that there would be a lot of demand to sell GBP, and market makers who were previously buying [GBP] for [USD 1.262] would lower their bids to [USD 1.260], and there’d be still more selling, and the market makers would start buying at [USD 1.255], and then [USD 1.250], and then [USD 1.245], and so on down, until the pound eventually settled at its new price.”

While it was an orderly and convenient system it was “kind of dumb,” Levine argues. “Everyone wanted to sell — the fundamental demand for the pound was in the [USD 1.24] area, not the [USD 1.26] area — but the market makers kept buying, at prices that kept getting lower, until when the dust settled they were left long a lot of pounds that they’d bought for prices that were now much too high.” The new system, while susceptible to flash crashes, allows for a “better trade,” Levine says; “computers, instead of buying all the way down to the new level, allowed the [GBP] to fall to an absurd level and then bought all the way back up to the new level.” Why is that? If the market moves are real, “trading against them is a money-losing strategy. The new, cruel, coldly logical regime involves electronic market makers who are too timid and capital-constrained and rational to trade against big moves. So they just let them happen — in fact, let them go too far and too fast — and then buy on the rebound, making money instead of losing it. Making money is better than losing money.”