Friday, September 19, 2008

SEC Temporary Short-Sale Ban Official: Capitulation or Manipulation?

It's official.  Chris Cox is insane.  He has chosen to follow in the footsteps of the loons at the FSA in London and put in place a temporary ban on short-selling of financials.  The ban extends to 799 financial institutions including banks, broker dealers and insurance companies.  The FSA's ban on short-selling on financials in the FTSE 100 has caused the mother of all short covering rallies on the FTSE 100, which was up around 8% the last time I checked.  I suspect there will be significant dislocations in the US markets as investors scramble to cover shorts.  The ban on short-selling offers a few exemptions, most notably to market makers in the stocks and investors who take on short positions due to an options expiration.  It doesn't, however, exempt options market makers beyond today's trading day.  By the way, did the SEC or the FSA know it was options expiration friday?  You'd think the regulators would have the sense not to impose a rule change of this magnitude effective immediately on a FRIGGIN ' OPTIONS EXPIRATION FRIDAY of quite possibly the most volatile week of trading the market has ever seen.
First, a wee bit of criticism, then I'll get to some predictions.  I firmly believe that short-sellers provide an invaluable pool of liquidity to the market.  Being a successful short-seller is extremely risky and difficult to pull off.  Short-sellers tend to be investors that dig deep into financial statements and root out fraud.  It was short-sellers that identified Enron as a ponzi scheme while all the Wall Street analysts, mutual fund investors, and the media were praising the company without asking difficult questions.  The market needs cynics.  Stocks are risky.  It is absurd to attempt to manipulate the stock market higher when the fundamentals of financials are so poor.  Is it true that investors were attempting to short the dealers in the past few days?  Absolutely.  Why?  Because the money markets were no longer willing to lend and dealers need the money markets to survive.  Did Mr. Cox and the other clowns at the SEC know that primary dealers borrowed $59 billion from the discount window yesterday?  That facility that no bank wants to admit to borrowing from because it is a lender of last resort and indicates the firm has run out of financing options?  You see, broker dealers have very risky business models.  You'd never actually know that if you listened to Wall Street analysts who continually forecast smooth earnings growth for them despite the fact that they operate in an extremely cyclical business environment.  Owning brokerage stocks is a risky proposition and investors need to fully understand the risks they are taking.  Owning banks and insurance companies has also been risky as of late because of the ridiculously loose underwriting standards that the industry allowed for so many years.  Short-sellers were short these stocks because they took the time to identify the underlying risks in the business and understood how toxic the assets on their balance sheets were.  The mutual funds and pension funds who are long these stocks should be ashamed of themselves for just believing that the stocks were cheap on a price to book basis, without caring enough to understand that the book values were grossly overstated.  So now, we're going to bailout equity investors?  Why?  Because the Dow was down 20% on the year?  Mr. Cox doesn't think that is justified given that financial firms have taken $500 billion in write-downs?  
My predictions are that we do get a huge rally in the market (obviously, futures are already up significantly.)  Furthermore, we will get crazy dislocations on specific stocks that have been actively shorted lately.  Some financials will be up 50%, 60%, maybe more.  This will possibly lead to some extraordinary losses taken in the derivatives market (and derivatives gains by people who were smart enough to anticipate this absurd action.)  But then, Mr. Cox has set us up nicely for a huge crash in financials once again when the temporary short-sale ban expires in October.  October, after all, is always a great month for a market crash. 


Airelon said...

Amen man.

I swear to you. If someone had come to me last week and said: "Could you engineer for us a crash of epic proportions"?

The first words out of my mouth? Would have been: Ban Short Selling.

I cannot understand this to save my life. It's like I'm living a chapter out of Atlas Shrugged.

K10 said...

It's an act of desperation by regulators who have no idea what to do. They just know that they have to look busy.
It is put buyers and short-sellers that support the market when it goes lower, as they sell their puts or buy-in their stock. If you don't let anyone short, who's going to buy stocks when everyone rushes for the exits at the same time?