With the SEC banning naked short-selling of brokerages, Fannie Mae and Freddie Mac, financials have just been given the green-light to continue blaming someone else for their predicament. Banning naked short-selling may seem tempting as it would create short-term stability in the markets and keep Fannie Mae and Freddie Mac from requiring bail-outs. However short-sellers didn’t create the underlying problems in these companies and likewise, banning short-selling won’t make these problems disappear.
Its the first step down a treacherous road as the SEC will soon “draft rules to the same issues across the entire market”. As abhorrent as hoping a company fails may be, the primary reason for the existence of financial markets is to optimize the allocation of capital and short-selling is a crucial part of that. Without short-selling, you’re just encouraging the creation of asset bubbles and making it a lot more difficult a correction to occur. Imaginary creation of wealth can never last and the lack of short-selling will just make the subsequent crash a lot worst.
Short-selling is banned in China, one of the underlying reasons behind the >400% run-up in stock prices, and now the staggering >50% stock market crash. In the long run, banning short selling will only mask the many problems faced by the financial industry. And with the SEC’s track record of dealing with problems, maybe that’s all they want to achieve.
EDIT 16-07-08: Whether it be correlation or just causation, financials have had a huge bounce today, the day after the SEC banned naked short-selling of brokerages.
16-07-08-financials
July 16, 2008 at 1:24 pm
SEC AND TREASURY want to legislate a restraint of free tade in our markets.
The mere suggestion that US markets are rigged will cause a pullback from domestic and foreign investors.
THIS IS HIGH NOON OF THE SOUL FOR US FREE MARKETS: will they remain so or will policymakers flinch in a panic reaction.
We all need to be aware just how much is at stake here.
Thank You
Dan Lasser
July 16, 2008 at 1:26 pm
Shorts can build a bubble of false pesimism too…it works both ways.
Some shorts behave like the “National Inquire” !
July 16, 2008 at 1:58 pm
Are the SEC and Treasury Dept merely playing favorites with Wall Street banks by restraining their short sales?
It is a very fine line to be asked to distinguish promotion of “stability” from simply arriving at political directives which favor Wall Street Banks and Brokers.
Why is laissez-fair the order of the day only when the share price of these public companies are rising? In simple terms, they are loosing money and that is all that is needed to explain a selloff.
Thank You
July 16, 2008 at 2:04 pm
What is the difference between “rumors” and news reports which get pulled and recanted? This seems to happen repeatedly on the long side, with no hint that such false rumors are a danger to the Republic.
It appears to be quite conveniant to quash “rumors” which suggest that a public company which happens to be in the business of investment banking might be guilty of unsound banking practises. Another way to regard this is a public service.
If “rumors” really guided people’s choices and behavior, the world would be one big reality shock!
July 16, 2008 at 2:16 pm
It does work both ways. But you don’t see the SEC banning people from going long. If the SEC banned people from buying technology companies during the tech bubble, there would be a riot!
The government shouldn’t be intervening in the market because it believes that certain companies should be trading higher, it should simply let the market decide for itself.
Note that bubbles of false pessimism are also a lot harder to create. Short interest as a percentage of the float is almost never higher than 50%. For example, Fannie Mae only has a short interest of 14.3% right now.
August 9, 2008 at 7:11 am
Almost a month has past:
-The Friday after announcing the emergency SEC ruling, MER revealed its Q2 report after hours on a Friday. Can you guess why? A 9.4 Billion writedown was announced, along with negative cash flow from operations for the 4th straight quarter and capital raising. The Fed had ensured the Bank of Unsound Practises was propped by the ban on naked short sellong, which had a political chilling effect on legal short selling, effectively eliminating shorts. Access to the Fed Funds window was wide open and extended. During the course of the last few weeks withdrawals at the window have increased.
Finally 10 days after announcing “no further capital raise needed”, MER raises 5.9Billion. Additionally it executes a dilutative share issuance to raise capital. 405 dilution. But the closing price the following day was up. Why?? Most shares were spirited away to Temasek, a foreign government soverign wealth fund, which essentially took those shares out of the float. Too bad MER had to compensate Temasek for losses on the previous equity capital raising.
Finally MER declares it’s huge residential mortgage backed insured CDO’s were worth about 5 cents on the dollar. Sold at 22 cents minus the 75% self-financing MER provided.
10 Days later another skeleton falls out of the closet: Auction Rated Securities. Criminal investigations in 2 states foced the disclosure. Small investors who were looking for return on principle, no speculating, in a low interest environment were told that the full faith and credit of the institution backed these instruments. They were essentially loans made to the Investment Bank. Another 10 Billion was legally required to offset those losses. Did I forget the capital raise achoeved through sale of a 20% stake in Bloomberg? Another self-financed deal which gouged the hope of any profit and rather cost the bank a bundle to be able to just cash out.
So MER is averaging 10 Billion every 10 days in writedowns and refunds. It has placed the market value of 2 of its most widely held securities at near zero. But don’t sell your shares yet! Company is hemorrhaging money at each quarterly report. Operations are losing money because of MER’s top-heavy, costly financial governance structure and methods rooted way in the 1920’s (armies of brokers calling the public, no meaningful direct access to trading)
It is clear that Merrill is ripping up the floorboards to throw in the fire for heat.
There is no net money being generated. And only though its substantial political connections can MER get the proper deal environment to performe these salvage operations.
Bad banking all around. It will become a classic case study in B School of the unwinding and delevaraging of huge debt during a crisis. It will serve to point out exesses of the “creative finance” era, especially in the case of derivatives. Also the deficiencies of “rocket science”, quant algorithsm that run adequately until theu arrive at the crossroads of machines panicking due to unforseen situations, There is just so much to discuss that the academics will be feeding like buzzards at the autopsy.