Short Sellers Off Target in Blaming the SEC For Ban

I’m willing to believe the S.E.C.’s decision to ban the short sales of 799 (or so) financial services companies amounts to regulatory overkill. But based on the objections I’ve heard to the move so far from the Jim Chanoses of the world, I’m not convinced. Here are their arguments so far:

Shorting stocks serves a several legitimate functions, like hedging. Fine, fine. The world’s financial system is in the process of melting down. Restrictions on short sales may help slow the slide in the near term. That would be a very good thing. In the meantime, and temporarily, investors can find some other way to hedge. That doesn’t strike me as a high price to pay.

Why blame short sellers for the mess? There’s no evidence they’re manipulating stock prices. Really? I’m still waiting to hear who bought all those Bear Stearns 25 puts last March a week before expiry. Besides, whether the manipulation was organized or not, there’s no question it’s going on, and is devastating. Surely no cabal met and secretly agreed to go after Morgan and Goldman once Lehman hit the fan, for instance. But that’s what happened, anyway. Morgan’s and Goldman’s funding models didn’t become suspect until Lehman failed, after all. But have you looked at the companies’ price charts? They’re both pictures of short sellers moving en masse on to their next victims.

Short sellers are vital in the market’s price discovery process. If I’m reading the VIX right, the equity market isn’t doing such a great job of rational price discovery, whether short sellers are participating or not.

So count me as unimpressed with the shorts’ objections. What the apologists have not talked about, meanwhile, is the issue the S.E.C. ban is presumably designed to address: the serial bear raids on financial services companies, such as investment banks, that turn speculation about insolvency into self-fulfilling prophecies. In case you’ve missed it, the process works like this: a) a short seller sells shares in an investment bank and buys credit default swaps on it; b) observers, including the bank’s customers, see its shares slide and CDSs on it rise,  and c) they become antsy about the bank’s viability and leery about doing business with it or providing it with funding; d) speculation persists, and shares fall some more while CDSs rise;  e) finally, customers and counterparties begin to back away, so that  f) everything goes splat. 

Back in the days when the financial markets were working and participants were brimming with confidence, this kind of thing didn’t happen. It does now. These are highly leveraged companies that have historically depended for their existence on counterparties willing to provide short-term funding. That may or may not be an obsolete business model that needs revising. But it would be a heck of a lot easier and safer for the industry to transition to a new-and-improved business model if bear raids don’t put a big chunk of the industry out of business along the way.

P.S. None of this is to be taken as an endorsement of the S.E.C.’s order. It’s just that objections to what the S.E.C. did would be a lot more convincing if they actually addressed the problem the agency is trying to fix.

Comments

[pdd:]

another Goldman lacky, oh! their quants could never be wrong.

2008 Sep 22 02:13 PM

[who:]

solving short selling is dealing with symptoms and cause is over leverage and wrong bet on mortgages

fundamentals are exists, USA buying all the toxic stuff should help the financial companies and real households.

2008 Sep 22 02:25 PM

[discov:]

You are full of sh1t.

You started your third paragraph saying that others claim short selling isn't proven to manipulate prices.

You finish the paragraph saying that the falling charts of GS and MS look like "pictures of short sellers moving en masse on to their next victims,".

You offer no explanation to us though...Mr. magic man...of how exactly you discerned the short manipulation in those charts. ...Mr. magic shorts....how do you locate the short selling manipulation on a chart...I want to be able to see the magic short seller manipulation signal as well.

so wright a second piece and tell us that and then it will be worth reading.

otherwise give me the 4 minutes of my life back that it took to read your article.

2008 Sep 22 03:54 PM

[JasonC:]

"how do you locate the short selling manipulation"

The instant Fannie and Freddie go away and shorts pocket billions, the shares of Lehman and Merrill and AIG drop off a cliff. The instant Lehman disappears, AIG doubles speed. The instant AIG goes splat, Goldman and Morgan Stanley drop off a cliff.

Um, you don't have to be a rocket scientist to gather than the shorts can't continue to be short a company that has gone to zero. And that their instantly being short another company with all their winnings, doesn't count as discriminating price discovery and just amounts to firepower gambling on the destruction they can cause, themselves.

Shorts can die and be damned, no one will miss them.

Congress cluelessly adding ridiculous conditions to urgent financial steps, on the other hand...

I hereby volunteer to be the only individual dealing with the treasury as it buys mortgages, so only my salary needs to be capped and regulated and prodded and probed. Everyone else can just sell to me and I'll sell to treasury. There! All better.

These politicos are just utter morons...

2008 Sep 22 04:22 PM

[discov:]

Jason C. and Stichnoth are you both still clinging to your claims that short-sellers are the magic wonder movers of stocks to the downside. If you didn't notice MS today. I think it fits all your prerequisites for a short victim........except there are no shorts in it today, because of the ban.

face it guys, you are both wrong.

2008 Oct 07 03:21 PM