The Longs are Getting Squeezed

Why are our banks failing? Obviously, it's the result of unrelenting traders shorting the companies for personal gain. How can any bank survive when so much money is betting against it? Surely being over-leveraged to the tune of 32:1 in many cases has nothing to do with it. Surely exorbitant senior management pay couldn't be a reason. Certainly pushing risky loans on borrowers with shady credit has absolutely nothing to do with it.

Unable to cope with the truth, and unwilling to take the blame, the banking industry has resorted to finger-pointing at short sellers. Not only has their finger-pointing allowed them to deflect much of the blame, but they've even convinced the SEC that short-selling is the culprit behind the financial meltdown. In what will surely become a case study in what not to do, the SEC banned short selling in over 900 financial stocks. Obviously, they figured that would be the finger in the dike that saved our financial world. Despite the ban, and a not too subtle $700 Billion taxpayer-funded bailout, the financials continue to hemorrhage capital. Obviously it's the short sellers. Oh yeah, there are no short sellers.

By enacting the short sale ban, the SEC has eliminated a key piece of insurance available to all those holding a long position in financials. The only way for a short seller to cash in his winnings is to BUY back the stock he shorted. Therefore, a person with a long position, despite the losses, had the assurance of knowing that at some point, there would be short sellers entering BUY orders and at least putting a temporary floor in the price of the stock.

One of the dangers in going short in a stock is the dreaded "short squeeze". If a large group of people shorted a stock, and the price moved higher, in order to cut losses, the shorts would have to BUY their way out of their positions, which leads to even higher prices. Thanks to the SEC, we are in a situation where "The Longs are Getting Squeezed." As financials drop lower and lower, shareholders must sell to cut losses. Only this time, there are no short sellers willing to cash in and buy those shares.

Unless the short sale ban is extended (God forbid), the ban will end at 11:59 PM ET Wednesday night. With multitudes of short sellers waiting on the sideline to jump back in and short the financials, we could be setting up Thursday for an even bigger train wreck.

Disclosure: none

Comments

[monday1929:]

This was a great laboratory experiment, but it will not change anyones mind- they will say, "imagine how bad it would have been with short selling".

2008 Oct 08 10:51 AM

[CLH:]

Anyone shorting banks at these levels is out of his head.

2008 Oct 09 09:11 AM

[Research123:]

So today they are shorting everyghing else. We are in a race to the bottom driven by unbridled short interest. Think about it for a moment: If a stock float is 100 shares, one can borrow all 100 shares and sell them inot the market, thereby inflating the float by 100%.

Our financial system cannot stand the waterfall effect of doubling the available shares of every stock one by one, which appears to be what is happening. The end game will be to starve all companies of new capital (can't sell new shares to expand if your stock has been driven down 50% by short sellers.)

What a great outcome for our country.

2008 Oct 09 03:12 PM

[Matt Callow:]

Thursday's train wreck??? Delivered! Dow -678 points.

2008 Oct 09 04:59 PM