Peak Insanity: SEC Plans to Temporarily Ban Short-Selling

Every time I think the height of insanity has been reached I have been proven wrong. My new official statement is: "There is no upward limit on insane actions by Congress, the SEC, the president, or for that matter anyone else."

Already I need to amend a post I wrote moments ago: Stock Market Cheers Fiscal Insanity.

I will add an addendum to the above post with a reference to this post on "Peak Insanity".

Here is the latest news that has caused me to change my mind: SEC Plans to Temporarily Ban Short-Selling:

The Securities and Exchange Commission took its most aggressive assault against bearish stock bets by stating its intention to issue a temporary ban on short-selling.

SEC Chairman Christopher Cox briefed Congress late Thursday of the agency's intention to take the extraordinary step of interfering with the market's regular functioning. Short-selling is a trading strategy of selling borrowed stock in hopes it falls and can be repurchased at a lower price.

It's unclear if the SEC's intention has been approved by the commissioners, which is required, and which stocks are covered or for how long it will be in effect. Earlier this summer, the SEC moved to restrict certain short-selling practices for 29 days, covering 19 financial stocks.

Thursday, the U.K.'s Financial Services Authority said it would ban short selling in financial stocks until January. The FSA said it would review the effect of the ban each month. The FSA also announced additional disclosure requirements from hedge funds of short-sales if a certain threshold is met.

The SEC's decision comes amid increasing concern that short-sellers are abusing legal trading strategies to drive financial stocks lower. Since the near-collapse of Bear Stearns & Co. in March, regulators have been looking into a combination of short-sales and false rumors as part of the problem.

U.K. Treasury Chief Alistair Darling, who was involved in the FSA's decision, said in a statement Thursday, he welcomed the FSA's "decisive action." He said in current market conditions it was in the "interests of financial stability."

The pressure to step up efforts against short-selling gathered steam since last weekend when Lehman Brothers Holdings Inc. steered toward bankruptcy and Merrill Lynch & Co looked for a buyer. Wall Street executives urged Mr. Cox to take steps to slow the sell-off, which they believe is triggered by heavy short selling.

Investment banks are particularly vulnerable to low stock prices as it hurts their ability to raise capital to secure their funding.

The SEC sped up its rule-making and on Wednesday the SEC announced three trading rules that were aimed at curbing abusive short selling. That was followed late Wednesday night with intentions to require hedge funds to disclose more information about their short positions.

Wrecking of United States of America

My friend "CS" emailed me this evening.

I am almost shaking as I write this for what is happening to the capital markets, this country, and the free world. The impact of the past two weeks' action in the financial markets, if not reversed by cooler heads, will have irreparably changed the world in a way that only terrorist attacks and acts of war have in the past.

Nationalizing Fannie Mae and Freddie Mac, providing an emergency quasi-legal bridge loan to AIG, temporarily banning short-selling on all stocks in the US, and instituting an RTC-type entity to handle the toxic waste of the financial system is economic violence on a grand scale.

The long-term cost of these actions to dollar holders will likely be in excess of $1 trillion. The basic premise of a free economy is one governed by laws and not men, where property rights are respected, where individuals are free to make contracts with each other, and where honesty and transparency exist in the marketplace. It's questionable whether any of these currently exist in the economy of the United States.

Before I continue let me provide a partial list of entities responsible for the financial mess we find ourselves in:

• Fractional-reserve banking, which is inherently unstable and entirely a confidence game
• Congress for passing the Federal Reserve Act and creating the Federal Reserve, the third central bank in the history of the US
• Woodrow Wilson for using the Fed to finance World War 1
• Benjamin Strong, the President of the Federal Reserve Bank of New York from 1914-1928, for inflating the money supply in the '20s to help out Great Britain which led to the Great Depression
• Herbert Hoover for his economic intervention from 1929-1932. He was not laissez-faire by any means.
• John Maynard Keynes for laying the foundation of a miseducated public
• FDR for banning private ownership of gold, enacting the New Deal, creating Social Security and Fannie Mae, and exacerbating the Great Depression
• The FDIC for lulling the American public into a false sense of security regarding their bank deposits and training the public to unquestionably trust the financial system
• LBJ for the guns and butter of the '60s
• Nixon for severing all ties between the US dollar and gold
• Reagan's intellectual duplicity, using free market, small government rhetoric while turning the US into a chronic debtor nation
• Alan Greenspan, one of the most duplicitous, arrogant, and incompetent individuals in the history of the United States. If I had to pin this crisis on any one man, it would be he.
• George W. Bush for cutting taxes while raising spending and his full embrace of Cheney's doctrine of "deficits don't matter"
• Ben Bernanke for following the Greenspan doctrine to its inevitable conclusion
• The heads of Fannie Mae and Freddie Mac for using artificially low borrowing costs to create systemically-dangerous housing institutions
• Christopher Dodd and Barney Frank for beating the socialist drum
• Christopher Cox for thinking a ban on short-selling will solve anything
• Hank Paulson for folding the hand he was dealt
• The ratings agencies for rubber stamping garbage assets as AAA
• The heads of the major banks and brokerages on Wall Street for turning a blind eye as their institutions were taking on massive leverage that threatens to take down the financial system
• The hedge funds that levered up structured finance to dangerous levels
• Generations of lawmakers for kicking the looming financial crisis can down the road
• Home buyers who lied about their income and creditworthiness
• Predatory lenders who put people into mortgages they could never afford

Frankly, I don't know where we go from here. Despite what government officials want, you cannot intervene your way to renewed credit and economic growth. The excesses of the past 25 years have come home to roost, and if we aren't careful this country's status as the hub of global capital markets and the holder of the world's reserve currency will disappear.

Freezing foreclosures, mandating artificially low mortgage rates, sweeping junk assets on bank balance sheets under a Level 3 rug, delaying the writedown of debt, pursuing a witch hunt against legitimate players in the capital markets, and having the government be the lender and borrower of last resort will do nothing other than recreate the mistakes of the 1930s. Short-selling isn't taking down financial firms, overlevered balance sheets of bad assets is.

This country has a lot of problems.

We have made commitments, militarily and to future retirees, that we cannot keep. We have an aging infrastructure and a reliance on diminishing fossil fuels. And we have lost confidence in the principles that led to our rise as the beacon of the free world. But there is a lot to embrace as well. We have great traditions of freedom and entrepreneurship. We have an educated, skilled populace that wants to make a better world for our children. And we have an undying belief in the American Dream, that hard work and thrift make the rags to riches story a possibility. But if we are to thrive in the 21st century we must reject the failed ways of the recent and not so recent past and rediscover that which made those who came before us proud to be American.

Thanks for reading,

CS

  Slope Of Bailouts Is Slippery And Expensive

On September 11 in Slope Of Bailouts Is Slippery And Expensive I stated:

A quick check of my calendar shows next week is options expirations week. What stunt might Bernanke and the SEC pull now? Eliminate naked shorting across the board through the end of the year? Conduct a séance? Howl at the moon?

I vote for the séance. There are many dead banks with whom Bernanke can communicate.

Apologies offered for the séance prediction. At least I considered the options. Most did not. With that in mind, I cannot predict (nor can anyone else) when this manipulated rally will fizzle out, one can only state that it will.

Those looking for a global equities crash are likely to get it if this resolution passes, and in fact may get one whether it does or not. Such is the nature of intervention into the no-longer free markets in light of the fact there is simply no such construct as "peak insanity".

Comments

[Wez:]

I'm frozen. My short ETF's got taken out at the neck yesterday and I can only imagine what happens to them today, yet I can't bring myself to drink this coolaid and start buying. Everyone, and I mean everyone on CNBC thinks the market goes higher today.....can it really be that easy?

2008 Sep 19 06:39 AM

[not here:]

The SEC had to step in and ban shorting. Because of incessant and non-regulated shorting, financial companies are failing literally overnight instead of it being a gradual process over months.

That kind of rapidity causes ultra panic in the markets and all stocks - even good ones with no link to financials - get sold off, and the cycle goes on like that until the markets are completely crippled.

Then its like a death grip. Like someone standing over an injured man lying on the ground and stepping on his windpipe.

2008 Sep 19 06:39 AM

[Archman Inv...:]

It is simply this in the ballgame of life.

Wall Street, The Elitists of this country, The Banks 1

Average Americans 0

All this communism will not be felt until 30 years from now.

My children and their children, are going to be paying for the inaction now of a scared general public who are to afraid to stand up and take back this country from the select few.

We can rationalize any way we want right at this moment, but by God there will be a price to pay for all this.

2008 Sep 19 07:23 AM

[morph366:]

When the European markets closed yesterday failing to rally after an injection of $180bn and Morgan Stanley and Goldman Sachs looked like they were about to be thrown on to the bonfire of vanities the authorities knew that they had to perform like true magicians. So we got two elements in a carefully planned set of leaks/announcements. Firstly the UK’s FSA came out with an outright ban on short selling of financials and then we got the news that an RTC type solution to the systemic financial crisis was being sketched out with Congressional leaders. Perfect timing and worthy of a true magician.

The nasty hedge fund fat-cats were set up as the distraction while the real illusion is performed which is that the effective nationalization of the illiquid assets of the banking system will restore confidence to the system. And it probably will - eventually and until the accident prone bankers screw up again!

What I like about the idea is that since it is still vague and has so many nuances and complexities to be ironed out it will allow for a stealth like alignment of the twin needs of separating out good bank/bad bank stuff with the other vital dichotomy private gain and public loss.

The timing of this was critical and is well reflected in the chart below for the VIX which shows that maximum fear as the 42 level was breached was the signal to the "authorities" that they really had no choice but to fire the biggest gun left in their arsenal.

One of the awkward questions that is going to have to be answered is what kinds of instruments will the RTC type entity be actually buying from the distressed banks? Presumably it will include all of the toxic structured instruments that do not trade, cannot be marked to the market and that none of the astrophysicists who concocted them can value either. What price should be paid for these exotic items? How long does the public sector keep them on its books?

2008 Sep 19 08:00 AM

[eddie6442:]

ANATOMY OF A COLLAPSE.............

2008 Sep 19 08:46 AM

[eddie6442:]

ANATOMY OF A COLLAPSE:
*The COMMUNITY INVESTMENT ACT, well intended, created the Sub-prime mess, helped along by the GREEDY money changers;
*SARBANES/OXLEY, an over reaction to Enron/Worldcom, incorporated a provision that Officers/Directors are "personnaly" liable for financial misstatement;
*FASB 157 created the MARKED-TO-MARKET provision which along with SARBOX "rapidly accelerated" markdowns of financial companies Balance Sheets and P&L's;
*The SEC greased the skids by "eliminating" the UPTICK RULE and "allowing" ILLEGAL NAKED SHORT SELLING;

SOLUTION THAT COULD HAVE SAVED TRILLIONS............
[1] SUSPEND the SARBOX "personal liability + FASB157 for 12 months while much of these subprimes were worked out and/or properly valued;
[2] REINSTITUTE the UPTICK RULE + prosecute NAKED SHORT SELLERS.

I'm not convinced that certain people didn't want this financial collapse to occur. One, THEY benefitted enormously on the way down. Secondly, THEY are ready-and-willing to BUY these assets for pennies on the dollar. And lastly, the financial system is now UNDER the CONTROL of a FEW POWERFUL INSTITUTIONS!!!!!!!!

IMHO

2008 Sep 19 09:01 AM

[varmit:]

I'm sure I'm not the alone in wondering if the actions on the part of the US government may be more harmful than the natural consequences of allowing the mismanaged institutions to fail on their own.

We will never see true healing in our economy as long as 'leaders' are
so willing to continue to pursue solutions that only deal with the immediate issues and continues to bury the future under an insurmountable mountain of debt.

2008 Sep 19 09:08 AM

[wpdragon:]

Free markets and capitalism... R.I.P.

2008 Sep 19 11:03 AM

[OldLimey:]

"The impact of the past two weeks' action in the financial markets, if not reversed by cooler heads, will have irreparably changed the world in a way that only terrorist attacks and acts of war have in the past."

By opening the door for Greenspan, Bin Laden seems to have brought down more than the Twin Towers. Sorry - no offence intended, but it's difficult not to join the dots. I'm as sad about it as anybody.

2008 Sep 19 11:47 AM

[wpdragon:]

OldLimey, I replied to you on another blog,will do so again here because you are absolutely correct.

Make no doubt about it, what the powers that be in Washington and New York have done to kill America's cherished tradition of free and open markets they fully intend to do to the Constitution, and the book burning attempts by Palin are a clear example of what we cam expect from this terrifying group of criminals.

We're on the brink of a police state run by America, Inc.

2008 Sep 19 12:23 PM

[upndown1313:]

Chris Cox should have been fired long ago. A little regulation long ago could have avoided the gross manipulations, that not until Goldman and Morgan became "manipulated", did we see that Cox started enforcing the law on naked shorting. I would have like to seen him delay puttiing on his new found "regulatory hat", and let Goldman sink to the depths they deserve.

2008 Sep 19 02:08 PM

[wpdragon:]

upndown... most of the the naked shorts were put on by hedge funds who were mostly spawned by the big IB's and MCB's, Cox's friends and supporters... i have no doubt they started eating their own when they realized the trouble they were in... they naked short the other guy's stock, so they could keep the eyes of the world off of themselves... but it just became a big circle jerk until Goldman was threatened, and then Hank came galloping to the rescue and Cox got his instructions.

It won't matter... this graphic on cnbc today was quite interesting:

"Dow has largest 2 day percentage gain in 79 years, since October 31, 1929."

How fitting and yet just slightly ironic... October 1929 was a swell time to buy and hold stocks.

2008 Sep 19 02:42 PM

[ozzy43:]

"The basic premise of a free economy is one governed by laws and not men, where property rights are respected, where individuals are free to make contracts with each other, and where honesty and transparency exist in the marketplace. It's questionable whether any of these currently exist in the economy of the United States."

Mish, please advise your friend that a 'free economy' has not existed in these United States for almost 100 years. This is the predictable culmination of a century's worth of State economic intrusion and corporatist authoritarianism. Welcome to the really real world.

2008 Sep 19 09:52 PM