By now everyone has heard about Knight Capital Group’s $440 million trading loss on August 1. The loss is devastating for Knight and its employees, who may soon find themselves out of work–or working for a new boss. Defenders of the status quo would like to point out that the only victim here is Knight and that the rest of the market worked just fine on August 1. In other words, nothing to see here, move along.
The truth is, Knight is possibly a more frightening red flag of dangers in the market than the notorious Flash Crash of May 6, 2010. Knight is a massive broker dealer that sat at the heart of the stock market. On many days it accounts for more trading on the New York Stock Exchange and Nasdaq than any other firm in the world. What’s more, Knight’s trading debacle shows that other brokers dealers–Too Big to Fail giants we’ve all come to know and love–are also at risk. Giant banks–all of them–have high-speed trading operations inside their walls, operations exactly like the one that erased nearly half a billion of Knight’s capital in a little more than 30 minutes.
Here’s the question: What would happen if such a “glitch” ate a hole in the balance sheet of a TBTF bank? Now we’re talking something else. Systemic risk–and tax payer bailouts. Again.