These are the main pieces of code if you are looking to understand how it works.

This is the section of code where the 10% 'haircut' rule is applied, and it basically reduces the amount of STEEM returned from SBD->STEEM conversions if the debt is above 10%:
https://github.com/steemit/steem/blob/bb8ca476f33c08434274f2d76333fcb74cfa58b8/libraries/chain/database.cpp#L3111

This is the section of code that reduces the SBD print rate as the debt ratio goes from 2% to 5%:
https://github.com/steemit/steem/blob/bb8ca476f33c08434274f2d76333fcb74cfa58b8/libraries/chain/database.cpp#L3452

Here is the section of code that processes SBD conversions:
https://github.com/steemit/steem/blob/bb8ca476f33c08434274f2d76333fcb74cfa58b8/libraries/chain/database.cpp#L2228

You can probably skip digging through the code and just think about it logically though:
1. Nowhere does the blockchain have any data about the SBD price.
2. When SBD->STEEM price conversions are done, it only looks at the price of STEEM to determine how much STEEM to create based on 1 SBD.

[Edit] I missed your other point.

> increasing SBD supply because of the increased supply by witnesses bias will generate more debt. Am I correct in assuming this? As in it will "flood" the markets with more SBD which in turn will create more STEEM debt?

If witnesses use a bias to artificially increase the STEEM price in their feeds, then it will print more SBD (which would increase the debt), but witnesses are not using a bias.