The right to herd

Just when you thought financial regulation couldn't get more expansive and incoherent, our Justice Department comes in to defend morons' right to herd.

As explained in the Wall Street Journal at least, Mr. Navinder Singh Sarao is now under arrest, fighting extradition to the US, and his business ruined, for "spoofing" during the flash crash.

What is that? The Journal's beautiful graph at left explains.

The obvious question: Who are these traders who respond to spoofing orders by placing their own orders? Why is it a crucial goal of law and public policy to prevent Mr. Sarao from plucking their pockets? Is "herding trader" or "momentum trader" or "badly programmed high-speed trading program" or just simple "moron in the market" now a protected minority?

Why is Mr. Sarao being prosecuted and not all the people who wrote badly programmed algorithms that were so easily spoofed? If this caused the flash crash (how, not explained in the article) are they not equally at fault?

I don't mean by this a defense of the crazy stuff going on in high speed trading. As explained here, I think one second batch auctions are a much better market structure.  But the whole high speed trading thing is largely a response to SEC regulations in the first place, the order routing regulation, discrete tick size regulation, and strict time precedence regulation. A fact which will probably not enter at Mr. Sarao's trial (he doesn't seem to have billions for a settlement) and will give him little comfort in jail.

And maybe, just maybe, there is something more coherent here than the Journal lets on. I'll keep reading hoping to find it and welcome comments who can.

A larger thought. We still really want to rely on regulators to spot all the problems of finance and keep us safe from more crashes?

Update: Craig Pirrong excellent commentary here via a good FT alphaville post. Great quote:

The complaint alleges that Sarao employed the layering strategy about 250 days, meaning that he caused 250 out of the last one flash crashes. [my emphasis] I can see the defense strategy. When the government expert is on the stand, the defense will go through every day. “You claim Sarao used layering on this day, correct?” “Yes.” “There was no Flash Crash on that day, was there?” “No.” Repeating this 250 times will make the causal connection between his trading and Flash Clash seem very problematic, at best.

Update 2: Reading various commentaries that I can't find to cite any more, I realize that "front running" more than "herding" is the protected class. You "spoof" by putting in a bunch of orders just outside the current spread. The algorithms that respond to that think this behavior means some big orders coming, so try to front run those by buying. They cross the spread to take the small order you put on the other side. Or so the story goes. In any case, viewed as spoofers vs. front-runners it's harder still to have sympathy for the latter.

Update 3: Good Bloomberg View coverage from Matt Levine  and John Arnold, the source of the above front-running observation.