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Refrigerator Rules; Flash Crash Solution?

19

May, 2010

The SEC has proposed rules, that take effect in June for a six month period, that would halt trading in any security that plunges 10% within a  period of five minutes for a period of five minutes. A circuit breaker is a great idea, and one that should have been self-implemented in a coordinated effort by trading venues in the past. It had not been implemented, as we can only imagine how hard it would have been to get a slew of these fellows in a room to agree and coordinate, in an age of finger pointing and secrecy. Kids can’t help themselves from fighting. Sometimes Mom and Dad (SEC) have to intervene. We applaud the SEC’s involvement, and encourage further involvement on their part. We think they need to make a set of rules to tape to the refrigerator.

The problem goes deeper. The circuit breakers are a band-aid on an infected wound, but the wound must be treated. Even though we have not found the cause of the Flash Crash, despite the CME claims yesterday, we have a solution? We demonize and tarnish a specific money manager, WDR, unfairly for the “greater good” of announcing an arrest quickly, because the city demands it? It’s like a bad Law and Order episode (if there is such a thing).

If we want a meatier solution, we must get to understand. To understand we must tag the dudes. That way, instead of guessing (and hushing) of what may have caused the Flash Crash, all the SEC has to do is hit the rewind button on the DVR! All they would need to do is frame by frame see who cancelled their bids, and who hit bids. And by the way it is not wrong-headed for a firm to not stand in the front of a train. We certainly wouldn’t. But if you are firm that receives perks like trading-parity, short-sale locate exemptions, higher rebates, and other perks, you should to some extent. If you are granted a license to make money for 62 days in a row, it is reasonable that we expect you to smooth it out on the 63rd. And for the hedge funds with no responsibility for maintaining fair and orderly markets, we totally understand you canceling and hitting HF STOP. We would! But please don’t flood the media with your specific benevolence towards the market in terms of providing liquidity. You guys provide it when you make money. You disappear when there is stress, which is fine providing you are not a DMM, etc. You just can’t talk out of both sides of your CPU tower; that is just plain disingenuous.

Addressing our market structure again, note that we have a system in the US where exchanges and ATS’s are owned by consortiums of brokers and HFT players. And we are surprised that the brokers have perfect trading quarters, and the HFT players have perfect trading 4-year periods? Come on. We are surprised that data gets provided legally that allows recreation of footsteps, and that allows certain players to re-create their own stock quotes and depth of books that differ in speed from the SIP? Really? That’s like being surprised that the PGA welcomes back Tiger. That’s like being surprised that a government official who is voting on rules that govern Fannie and Freddie has relatives that work for Fannie and Freddie

Oh and regarding the solution I have read by one industry executive, that we need to eliminate an “old-fashioned” order type called the market order, I am saddened.  We are now sending the world  the message that they shouldn’t have the confidence in our markets to send it a market order. Shocking. I guess the fact that we have three times the volume we had a few years back certainly does not mean we have three times the liquidity.

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