Why Short Selling Is Not the Problem

by: Keith McCullough

The New York Times (3 July, “SEC May Reinstate Rules For Short-Selling Stocks”) reports that the Commission looks set to bring back the Uptick Rule, abolished by the Commission under Chairman Cox in 2007.

The Rule, voted out based on studies that seemed to show it had no effect on market stability, is on the political agenda. According to the Times, House Financial Services Committee Chair Barney Frank is pushing SEC Chair Schapiro on the issue, as is Delaware Senator Edward Kaufman, who has introduced a bill to reinstate the Rule.

It appears that reinstating the Uptick Rule will end, at least temporarily, the long-winded discussion over short selling circuit breakers. This is presumably good news on many fronts – not least for the politicians themselves. It will enable Frank, Kaufman and others to show instant action on a subject that they have made sure is uppermost in the minds of their constituents – even those who do not know what short selling is.

Underlying the battle over short selling is the fairy tale about unfettered growth. “Think and grow rich,” wrote Napoleon Hill.

The mantra of both Wall Street and Washington is, “Let us do the thinking – and you’ll grow rich.”

Under the mysterious machinations of the Maestro – Alan Greenspan – the nation was lulled into a sense of entitlement. All we had to do was buy stuff, then sit back and wait for it to go up in price. Then we bought more stuff. Then we used that as collateral and leveraged it to buy still more. Irrational exuberance – shamelessly promoted by the most irrational of them all – led us to where we are today.

Short sellers have long been seen as un-American. As a balance, we offer a piece from this weekend’s Wall Street Journal (3-5 July, “New Evidence On The Foreclosure Crisis”), in which Stan Liebowitz, of the University of Texas, Dallas, argues that the greatest single contributing factor to the foreclosure crisis was not subprime loans, but zero money-down mortgages. The incidence of defaults among zero money-down mortgages far outweighs those among subprime, NINJA (“No Income, No Job or Assets”), or “liar” loans.

The Mortgage Bankers Association’s own statistics show “that 51% of all foreclosed homes had prime loans. Not subprime, and that the foreclosure rate for prime loans grew by 488%, compared to a growth rate of 200% for subprime foreclosures.”

What, then, is determinative? In the figures quoted by Professor Liebowitz, the twelve percent of homes having negative equity accounted for 47% of all foreclosures. No skin in the game.

This is the new American dream: working for what you want, and keeping what you build, has been replaced by "something for nothing".

"Something for nothing" became the driving force behind Wall Street. In the 1980s and 90s, tens of thousands of young men flocked to Wall Street where the business was fueled by OPM – other people’s money. No one has had skin in the game for a generation. No one except the customer. And now – as a result – the taxpayer.

Regulators and brokerage managements insisted that financial salespeople not invest in the same instruments they pitched to their customers. Under the guise of conflicts of interest, the purveyors of investments were insulated from the negative effects of owning them. Investment banks, meanwhile, created product – in the form of deals and public offerings – promoted them through their own in-house advertising agencies – research departments – and pumped them through their own distribution pipeline – the brokers.

Ultimately, that model caused a global crash – because not everyone can get out the exit at the same time. Short sellers, dubbed unpatriotic because they take up permanent residence outside the exit, are our society’s Mark of Cain. In a culture that has confused owning with creating, it is virtuous to possess. It hardly matters what – just go out and obtain something. If you can not afford it, we will arrange for you to borrow the money. Or you can buy it with OPM. Or, as Professor Liebowitz’ research indicates, if you can not afford it, we will give it to you anyway.

In a seemingly unrelated story, the Wall Street Journal had a front-page item (1 July, “Finance Lobby Cut Spending As Feds Targeted Wall Street”) saying political contributions from Wall Street to Washington are down a whopping 65% in 2009, as compared to 2007.

Also, there has been an upward trend in giving to Democrats over Republicans – which only makes sense when you consider a random list of Dems in a position to exert influence on Wall Street: Barney Frank, Chuck Schumer, Chris Dodd, Henry Waxman and Barak Obama come to mind, just to name a few. By making the fuss about short selling go away, Frank and his cronies hope to emerge as the good guys in this debate.

Clearly, the outcome most devoutly wished by all is a return to business as usual – investment bankers will return to doing deals, private equity will gobble up banks, brokers will go back to cramming deals in their customers’ accounts, and the money will flow back from Wall Street to Washington.

Short sellers are not the heart of the problems facing the world’s economies today. The real question is, who will rein in the long buyers?

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