Who's Minding Our Markets?

This morning, CNBC's morning program is still beating a loud drum regarding the sudden drop in equity prices on Thursday afternoon. To facilitate the process, they invited Pennsylvania Democrat Representative Paul Kanjorski to be a guest host. Kanjorski is a member of the House Financial Services Committee, thus, his attraction for CNBC. Talk about one hand washing the other......

It's ironic for CNBC to have Kanjorski guest host to discuss Thursday's alleged trading scandal, because Kanjorski is actually a scandal-tainted legislator, himself. I found this out due to an accident a month or so ago. At the time, I had written a post on one of my blogs involving Kanjorski. Reading through my Sitemeter details of visits, I found that one reader had found my post from a search for 'Kanjorski scandal.'

Sure enough, Kanjorski, a Representative since 1984, has a big earmarking scandal in his past apparently involving using millions of dollars of federal money to enrich his family. Wasn't Kanjorski's regionally-close, Pennsylvania Democratic House colleague John Murtha, also known for excessive, often self-serving earmarks, too? Must be something in the water up in Northeast Pennsylvania.

Anyway, knowing this makes Kanjorski's earnest-looking, solemn attitude regarding finding and punishing equity market traders and 'insiders' much more of a joke. After all, it seems Kanjorski is a veteran 'insider' himself.

But, back to the issue. Kanjorski has been spewing all manner of hot air this morning, no doubt to make ideal campaign sound bites and video clips. Particularly, he went to great lengths to extol the current financial market regulatory personnel as just the best "in 25 years." Really. Honestly.

No matter that a Democratic administration staffed those agencies. And Democratically-controlled committees are taking a 'hands off' approach with Mary Shapiro in the wake of the incident.

And, as I'm writing this, Kanjorski is lampooning voters who blame CRAs, Fannie and Freddie for causing much of the recent mortgage-backed financial meltdown. That, alone, should tell you that Kanjorski is living in an alternative universe where Congress has never done anything to damage our financial system.

By now, though, it's pretty clear what happened on Thursday. The NYSE used its human specialists to engage a trading slowdown. Claiming that a two minute pause in trading does not constitute 'stepping away' from the market, the NYSE chief and his colleagues and defenders all claim they were merely bringing 'order' to markets run amok from too much electronics.

When the NYSE's specialists essentially took a hike on selected equities, the order flow immediately went to the NASDAQ, which, because of the NYSE's absence, had to order match in a less-liquid market. With more sell orders than buy orders, the 'real,' instant market prices fell.

I really don't think what happened is much more complicated than that.

You can conjure up all manner of conspiracy theories, but, in reality, it does seem to be a case of the regulatory authorities allowing for one exchange to engage equity-specific trading halts, while allowing another exchange to trade through.

What do you think will happen in cases where this differential treatment of individual equities occurs? In down markets, prices will gap down. If Thursday had been an up day, prices would have been skipping up discontinuously, and buyers would have complained about missing bids and being filled at what they considered to be ridiculously high prices.

The truth is, the definition of a "market" involves several dimensions. No one buyer or seller can set prices. Prices must be continuous. Price discovery has to be ubiquitous.

If any of these tenets are violated, it's not a 'market' anymore. Therefore, 'market' orders aren't really going to have their desired effect.

Funny how it's become pretty obvious that the cause of Thursday's ultra-sharp sell-off is a regulatory mistake of keeping exchanges in step with each other. But, because it was a regulatory lapse, the party in power is looking elsewhere for someone to blame.