SEC: Don't Mess with Market Mechanics

With the SEC banning naked short-selling of brokerages, Fannie Mae (FNM) and Freddie Mac (FRE), 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.

Comments

[fxtrader07:]

another moron who has no clue and cannot distinguish between naked short selling and the legitimate short selling against genuinely borrowed shares.
naked short selling is actually illegal already. so you have to wonder why an illegal practise gets banned just temporary and for a few selected privileged companies.
before you write such silly crap you might want to get some education about the ongoing crime and scam of naked short selling first.

2008 Jul 16 06:57 AM

[Jimmy Lathrop:]

As long as legitimate OTC futures contracts and swaps are allowed, its not going to affect legitimate short ETFs. Which banks have been pouring millions into. Sort of like calling up the insurance company and increasing your coverage when you see Grandma fell asleep with a cigarette and now the curtains are on fire. More barking, no biting.

2008 Jul 16 08:34 AM

[trubletru:]

the writer of this article seems to be blinkered with respect to the blatant manipulation of markets by the spread of false information to affect the performance of certain stocks in lieu of political scenarios. his sophomoric article is a form of dis-information, seemingly a damage-control ploy aimed at having a political impact. face it, scambag, most of the finance industry generates no economic benefit as an industry in the political economy, it simply tries to generate profits for itself through collusion (of which spreading intra-industry false info would give rise to a herd mentality defacto form of collusion), and generally accomplishes that by undermining the free market. it's like an exclusive secret society that pretends to speak in tongues, when they really are just generating noise to mask the lobbying efforts to enable energy stocks to be traded on a non-regulated basis outside of the country, etc.

2008 Jul 16 01:47 PM

[ValueInvestor:]

fxtrader, you are bang on.

This writer is a fool and can't distinguish between the two. Its the same thing as people thinking speculation = manipulation. They are two very different things.

2008 Jul 16 02:31 PM

[ValueInvestor:]

I would encourage everyone to watch "Deep Capture: the movie" and read "Deep Capture: the Mitchel Report" at deepcapture.com

It will open your eyes to the whole "naked" shorting process and what it can do to a company.

2008 Jul 16 02:45 PM

[Jason Liu:]

"Naked short selling is not necessarily a violation of the federal securities laws or the Commission's rules. Indeed, in certain circumstances, naked short selling contributes to market liquidity."
www.sec.gov/spotlight/...

Ironically, banning naked short-selling of the brokerages actually keeps your " finance industry [which] generates no economic benefit as an industry in the political economy" alive.

The markets are there to allocate capital efficiently. Manipulation of stocks, whether up, or down is always detrimental. However, preventing people from making directional bets is never a good idea.

2008 Jul 16 03:37 PM

[ValueInvestor:]

Jason, your missing the point. It says "not necessarily a violation" means that while honest market makers can naked short, others that intentionally do so without any intention of ever borrowing the stock or buying it back is illegal.

2008 Jul 16 05:42 PM

[Byzantine R...:]

I think it's shameful that the regulatory agencies are taking such a partisan stance in the market.

Is this obvious short squeeze going to be coupled with a confidential exhortation to market makers not to lend shares in these troubled institutions? Are they going to strongarm market players to buy large blocks of shares in a "show of confidence"? Can there be any clearer sign that the regulators have been co-opted by the money center banks and contaminated by moral hazard relating to the public-private nature of the GSEs than this jawbone intervention?

Why do we even have this market at all if we're only comfortable when it's generating the next asset bubble, not when it's correcting? If our investment decisions are to be based on policy preference and not market forces, why not cut out the charade and just call it "taxation"?

2008 Jul 16 08:45 PM