Thursday, April 9, 2009

Uptick Rule? Who Cares?

One would assume that after several large banking institutions have gone bust, and many have posted astonishing losses and required enormous cash injections from the government, our regulators would maybe stop blaming the credit crisis on short-sellers. Perhaps after not a single charge has been brought against “rumor mongers” and “abusive short-sales” following on the heels of the plunge in the stocks of Bear, Fannie, Freddie, Lehman, Citi, BofA and AIG, one would come to the conclusion that this whole mess has nothing to do with abuses by short-sellers. Maybe the market is actually efficient, and short-sellers are just more skeptical of rosy projections offered by CEO’s, such as when Bear’s CEO Allan Schwartz appeared on CNBC and proclaimed that his company did not have a liquidity problem the day before his company ran out of cash? Or maybe when Lehman’s Dick Fuld kept insisting that his company was fine, right before the bankruptcy revealed a gaping $150 billion hole in its balance sheet. If a company is actually solvent, senior secured bond investors get more than eight cents on the dollar in a bankruptcy recovery. Really, do I even have to say any more about AIG? The insurance company took extraordinary risks and despite the fact that many Wall Street analysts somehow missed this crucial part of their business, anyone with a basic understanding of derivatives could’ve easily seen that it had too much risk relative to its capital base. Short-sellers weren’t trying to drive the insurer out of business. AIG drove itself out business. Short-sellers just thought the trade was a layup.

The SEC is once again trying to decide what to do to “reign in the shorts,” as if that somehow would’ve kept many of our financial institutions from becoming insolvent. The regulatory agency is holding hearings on bringing back the uptick rule, as well as instituting a circuit breaker that would be triggered when an individual security falls more than 10%. As a former professional options market maker for several years who shorted stocks only when hedging an options trade, I can say with authority that the uptick rule was good for one thing: allowing the New York Stock Exchange specialists to manipulate the price of stocks so they could make a couple extra pennies per trade. It didn’t do anything to stop the plummet in Nasdaq stocks in 2000-2002. We had a tech bubble and tech stocks went to $300, the bubble burst and they went back to $2. The uptick rule, in my opinion serves no purpose, but is completely benign (if you pay no attention to the cost of implementing it.) Who cares? Why is the SEC even wasting time discussing it? The circuit breaker is a dumber idea and would allow market participants the ability to game the system. The more the SEC restricts the ability to trade stocks, the less the participants will want to trade. A lack of liquidity is never good for markets.

Maybe the SEC should spend some time reflecting on why it failed to adequately monitor our investment banks, since it decided to allow them to leverage 50 to 1. Perhaps it can spend some time analyzing why it failed to investigate, oh I don’t know, a $50 billion ponzi scheme, when it was warned about it several times. That’s just a few suggestions to start with. I have many more.

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