SEC About to Blame a Small Trading Firm in Kansas for May 6 Flash Crash

Yeah right. No mention of High Frequency Trading, no mention of quote delay in NYSE.

I read the article on Bloomberg, and was about to write a post.

Zero Hedge beat me to it:

Bloomberg has just released something which if true, will wipe out every last ounce of credibility left in the market. As readers will recall, the initial scapegoat that CNBC and everyone else, who has no clue what really happens in the market decided to pin the flash crash on, was small Kansas-based trading firm Waddell & Reed, which traded a few extra contracts of E-Mini futures in the hours preceding the flash crash. Well, ladies and gentlemen, if this advance glance into what the SEC is about to disclose in its flash crash report is indeed valid, then the entire flash crash is about to be blamed on Waddell and Reed once again, with no mention of High Frequency Trading, or any of the other real culprits for the drop which wiped out $1 trillion in market cap, and the furthermore the report will have no policy recommendations. This is so insulting to the general intelligence of the average American investor who has by now seen the destructive influence of HFT in action so many times, that it will wipe out the last remaining shards of credibility left in US stocks. Will Mary Schapiro next blame every single mini flash crash which we have seen on almost daily basis over the past month on Waddell and Reed as well? Or is that reserved for E-Trade retail accounts? We will not pass judgment until we see the final report, but if true, this is immediate grounds for termination of the SEC head, and will require that everyone pull their money from the market asap, as it will definitely confirm that even our regulators have no clue just how broken the market truly is. It will also confirm that every single SEC staffer has been bribed, bought and corrupted beyond repair by the HFT lobby.

In case you haven't caught on yet to what really most likely caused the flash crash that clearly triggered the 21 consecutive weeks of outflow from equity funds, here it is.

Will HTF algo bots walk scot-free? Where will they go next? Someone at CNBC thinks it will go to CDS market, which is currently OTC but will be forced to move to exchange trading and clearing under the new financial regulation bill, and it may not be a pretty sight:

Let's imagine, however, what a flash crash might look like in the CDS market.

Let's say high-frequency traders have become liquidity suppliers to the market, buying and selling bond protection. The broker-dealers have stopped providing this liquidity, in part because their profits have been squeezed out of the market by the new transparency. One day, an event somewhere in the world triggers the algorithms of a few highly correlated HFT shops to start buying more protection on a wide variety of stocks.

This triggers other HFT programs to stop selling, which triggers more buying. Prices on CDS soar across the board. The clearing houses start demanding more collateral from everyone to reflect the higher prices, triggering a rush for cash by everyone participating in the market.

Meanwhile, the risk management operations of institutional investors detect the soaring CDS prices, which are read to signal that the bonds are about to become distressed. The corporate bond market sells off and even more buyers for CDS enter the market. The short-term credit markets freeze up as money market funds stop providing credit to what look like increasingly risky corporate borrowers.

And then the clearing house notices that some market participants aren't making good on the collateral calls, so it starts closing out their positions. Outsiders get wind of this and begin to doubt the solvency of the clearing house, triggering a run on the clearing house itself. With no one able to process trades through the perhaps insolvent clearing house, and all other alternatives have been declared illegal by Dodd-Frank, the credit markets seize up completely.

The next thing we know, we're all hearing about emergency meetings down on Maiden Lane, where bankers and regulators are putting together a plan to fend off the next Great Depression. The plan is elegant and its proponents are articulate and highly adroit at defending it against critics. It involves the transfer of risk from the private market participants to the taxpayers. It is, in short, another bailout.

Can we handle a flash crash in the bond market? Are we prepared for a freeze in derivative clearing? Has anyone even asked these questions?

But what the heck, as long as the gullible taxpayers exist....

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