The all wise and knowing mandarins of economic policy and free markets have now issued a new decree: thou shalt not short-sell.
In essence, by banning short-selling of almost 800 stocks our 'leaders' have informed us that the only good market is one that goes up, up and always up.
So, I have a few questions for them, based on what I know of the market and some of the possible unintended, or unforeseen consequences.
First, what happens to people who write puts on stocks?
Second, what happens to people who buy puts on stocks?
Third, what happens to all the money people have invested in 'short' mutual funds? Or short ETFs?
Forth, what about the indexes? Can those be shorted if they have even one of the almost 800 financial stocks that have been banned from short-selling?
Fifth, what happens if there is no bid? Do markets freeze up?
Sixth, what happens to the men and women who built up businesses, or funds, in good faith, who manage money for people that are short funds? Are they out of business?
These are just a few questions. I can imagine many, many more. I cannot even begin to describe the contempt and rage I feel for the people who put this edict in place. It's lunacy.
We are now going to see the mother of all short squeezes and I would not be surprised to see this have the exact opposite effect policy makers seek and liquidity will dry up.
What the heck ever happened to efficient markets? What about price discovery? How about plain old free markets?
This is the most insane, counter-productive, anti-free market, anti-competitive edicts I have ever witnessed in my life. I submit to you that a halt in trading of financial stocks would be less counter productive than this.
We are, literally, being ruled by morons. If ever there was a 'Hoover-moment' in this Administration this would be the one. And we will, at some point rue the consequences. Short-selling is an essential safety valve for the markets and banning it, as I have already said, is simply insane. The act of desperate men to hold on to their ill-gotten wealth.
Capitalism is dead. Long live capitalism!
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Comments: 26
If the current administration is at fault, which it is, it's for being asleep at the wheel while hedge funds have taken the market to its knees through short selling. The administration is not at fault for trying to restore faith in the market and regulating it to behave as ordinary investors expect it to behave.
How does short selling work? Some fool like me hands a parcel of hard-earned money to an investment management fund and says 'Please manage this money for me because you know more about share market investments than I do'. The investment management fund goes off with my money, and money belonging to thousands of other trusting investors, and buys shares in Schmuck Brothers.
A hedge fund decides it's going to take a short position on Schmuck Brothers. It approaches my investment management fund and says 'May we borrow your shares in Schmuck Brothers for two days? We'll pay you a small rental and the shares will be returned to you within 48 hours'.
My investment management fund, which is managing my retirement funds on my behalf, agrees to loan the shares in Schmuck Brothers to the hedge fund. The hedge fund goes into the market and offers the borrowed shares for sale at a fraction of what they're worth. Naturally everyone wants to buy them at this low price, so a new base price is set for shares in Schmuck Brothers. Because of the dramatic fall in the on-market price for Schmuck Brothers shares, the price collapses. They've gone from something to nothing very, very quickly. The hedge fund steps in and buys all the shares it can from shareholders baling out of Schmuck Brothers.
At the end of the loan period the hedge fund returns the borrowed Schmuck Brothers shares to my investment management fund and pays the loan fee. Can anyone see a problem here?
The problem is that the Schmuck Brothers shares I paid the investment management fund $x for are now worth a fraction of $x, and I've lost my retirement nest egg. Worse, nobody consulted me about the deal.
In some cases, known as 'naked shorting', the hedge fund doesn't even bother to borrow the shares in Schmuck Brothers. Instead it goes into the market, offers shares it doesn't own at an artificial low price, then buys shares at the new low price to cover it's position.
At times like this, where is the 'invisible hand' that free marketeers like to theorize will keep order in the market? It's very invisible, believe me, and it's very ineffectual at keeping order in the market. Invisible vested interests are manipulating the market.
It's time for the visible hand of the regulators to take control again, otherwise the stock market will collapse for no evident worthwhile result.
And you are mistaken in something: mutual funds cannot, by law in the US, loan shares out. It's called commingling of assets and it is illegal, not to mention a huge conflict of interest.
Short sellers borrow shares from big investment banks-I know, I used to work for one and worked in the arbitrage department. I was also an arb clerk for a year on the floor of one of the exchanges. You fundamentally misinterpret how short selling is done and the mechanics of it.
Great points and I like the ending of your tirade!
The act of desperate men to hold on to their ill-gotten wealth.
Capitalism is dead. Long live capitalism!
If a broker is trying to convince me to buy shares he'll pull out charts that shows how markets always go up over time. And they do go up over time. Occasionally markets drop, but when that happens they usually recover within a few months. You've been in the industry, so you know this, right?
I'm in Australia, and retirement funds here are allowed to loan shares to short sellers. I'm talking about my retirement fund when I say 'my investment management fund'.
Short selling has always been part of the market mechanics. What's changed dramatically in recent times is the influence of hedge funds on the market. You and I can't easily borrow shares to participate in short selling, but hedge funds can.
If a hedge fund decides that a particular bank looks vulnerable, the hedge fund can short it and once the shorting starts the bank has little chance of survival. Other hedge funds will join in because they see an opportunity to make money in a falling stock.
But it's not just the value of the bank's stock that the hedge funds are bringing down. Public confidence in the bank will also suffer, causing depositors to withdraw funds. We've seen this happen with Northern Rock in the UK, and a few more famous banks in the US.
If short selling is such a critical function for the market, and don't forget that the market is made up of millions of nervous investors, the regulators in the US, the UK and Australia wouldn't be banning short selling in selected financial stocks, would they?
And this is THE question. And I guess this one comes down to a matter of opinion and principle. For me the principle in question is the whole idea of efficient and free markets. I happen to believe markets should be free. Free to go up and free to go down. That's the principle I am standing on here. As I have said in other places, I have no love of short-sellers. But I do have a love of principle.
Second, as to opinion on the matter: I happen to think the authorities in the Anglophone world are doing what they are doing because they are trying to prop up a failed system. A system based on poor ratings and poor credit-worthiness and extreme corruption and mismanagement. And in my opinion, a system like that needs to be cleared out by free price discovery.
And if I were your broker I would have told you months ago to be in cash, gold, the Euro, the Swiss Franc and the Yen. Not equities. I still manage money for some people and that is where they are and they are properly positioned to weather this. But that's because I knew this would happen. People not smart enough to see this, or who have wealth advisers who only follow the company line, well, in my opinion, they deserve to lose their money. After all, it's a free market and you are free to put your money wherever you want. But when you take the risk and put your money in equities, you can't call foul in the middle of the game when they are going down. You can't change the rules and that's where the principle comes in. Markets must be free to go up and free to go down. It really is that simple.
Here are a few quotes:
And this:
Government has no business in banning practices like this because it always makes the problem worse. My point is proven beyond a shadow of a doubt now.
You say, "I knew this would happen. People not smart enough to see this, or who have wealth advisers who only follow the company line, well, in my opinion, they deserve to lose their money. After all, it's a free market and you are free to put your money wherever you want. But when you take the risk and put your money in equities, you can't call foul in the middle of the game when they are going down. "
Good on you guy. But the problem is there are a whole lot of little people out there who aren't nearly as smart as you, people who have money invested in equities that they were, perhaps foolishly, relying on to fund their "golden years". After witnessing the kind of chaos we've seen this past week they may be tempted to take their nickels and dimes home and stash them under the mattress, and who can blame them? When that happens you're not going to have much of a market anymore.
Free-wheeling free-market capitalism isn't looking like such a great concept right now. I'm amazed that the townsfolk aren't marching down The Street with torches and pitchforks, eager to spear some of those heavily larded stock-traders asses.
It's the gaming the markets from the top that has me pissed off and the no short-selling rule was nothing more than a manipulative attempt to prop up the last few investment banks and the rich men who own them. It's rank hypocrisy, especially with Paulson carrying water for his Goldman Sach mafia.
Let's clear up a couple of points.
1. I've never bought a share in my life, so I don't have a broker to advise me about anything. I've owned shares in private companies that I've owned, but I've never owned a share in a public company.
2. In Australia we have a compulsory savings scheme called 'superannuation'. Everybody, bar none, has 9% of their salary deducted and put into managed funds. It's the law. The only choice you have is the choice of fund, and you can choose from a number of investment options offered by the fund. You can choose Fund A's Balanced option, or Fund B's Capital Growth option, but you can't opt out. You can put in more than 9% if you wish. All money going into superannuation is taxed at 15% on the way in, and it comes out tax free. But you can't get your superannuation until you reach 65 years of age. Dammit!!
So, in Australia we're all shareholders in a general sense. That makes us very interested in which way the market is moving. It also makes us very interested in well regulated markets.
If the market's going up we're all happy, and the revolution is permanently on hold. If it's going down like it's been going down lately, we become very unhappy, believe me.
My superannuation nest egg has gone down 25% since January. I haven't got the option of pulling the money out and putting it into bullion or real estate unless I've reached 65. It's like watching your money burn, and there's nothing you can do about it.
Lots of people, as Paul notes above, rely on stock market investments to fund their retirement. We don't see the market as a casino. That's why we want it regulated. That's why it has to be regulated.
Yes, lots of people rely on markets for their retirement. But that doesn't mean they should. The whole point of investing a portion of ones nest egg in equities is to outpace inflation. The vast majority of anyone's holdings should be in fixed income, secure instruments.
That's why we had a huge fight in America about privatizing Social Security. The point we on the left were trying to make is amplified and expemplified by the experience you are so unfortunately having to endure.
Gather Broadcasting: Have it your way
This takes you in the front door, and this takes you in the back door. If you’ve been, don’t click again.
In other words, investor confidence has returned to the market. QED.
----- NEWS REPORT - Australian Broadcasting Commission News service, 22 Sep 2008 ----
The Australian share market has surged 3 per cent after trading was delayed for an hour as more information was sought about the Federal Government's ban on short-selling.
The Australian Securities Exchange delayed trade so it could obtain further clarification from the corporate regulator on the ban, which prohibits most forms of short selling for 30 days.
The ban was put in place after a number of countries including the United States and Britain banned short-selling of financial stocks to stop traders making money out of the turmoil on global financial markets.
A short time ago, the All Ordinaries index was up 175 points or 3.5 per cent to 5,016. The ASX 200 has gained 160 points to 5,000.
Debt-laden investment bank, Babcock & Brown, has jumped 80 per cent. The Australian dollar is buying around 82.9 US cents.
Earlier today CommSec's chief economist Craig James says short-selling should have been banned years ago.
"If you don't like a stock you shouldn't be investing in it in the first place, you shouldn't be selling it down and disadvantaging ordinary investors and superannuation holders," he said.
Mr James says he sees the ban as a positive move.
"There will have to be a little bit of short covering for those companies that have been selling down stocks and that may provide a booster to the share market.
"We're looking for the share market to open up 150 points higher but given these significant short selling curbs it may be a fair degree higher."
Mark my words, this isn't over, not by a long shot.
Another cardinal rule of investing: every time a trade is made, someone has made a mistake.
If I were in your shoes and I had a choice, I would move to a full cash position. Make no mistake, however, I am not offering investment advice. I am just informing you what I would do.
And you can QED me all you want. I HOPE I am wrong. But I seriously doubt I am. Let us revisit this in six months and see where we both stand, shall we?
I have no problems admitting I am wrong. That's another cardinal rule of investing: admit your mistakes quickly and move on. So, in six months, will you have the character to admit you were wrong?
in fact, I think you both do.
I can't get my money out. It's locked in until I turn 65. Millions of Australians have billions of dollars locked into their superannuation accounts in the same way. That's why governments here and elsewhere have been forced to intervene. Everyone knows that hyper-interference by hedge funds is the problem to be solved.
The market activity we've seen in the last few days is not the result of a free market sailing along at full steam, obeying all the rules and being governed by Adam Smith's theoretical 'invisible hand'. This is a market feeding on greed. The hedge funds are aware that most banks are overexposed to junk derivatives created in the heady days of sub-prime adventurism. So the hedge funds attack the banks by short selling their stock. It's an easy way to make a buck, as Cheri points out above. Welcome aboard Cheri!
If this wasn't the biggest threat to world economic order since October 29th, 1929 I would agree with you and say 'Let the market sort it out'. But there's more at stake here than a few bankers getting their come-uppance. Much more.
With several major economies in recession and stock markets everywhere in turmoil we could be looking at mass unemployment and business failures around the world, something that goes way beyond the stoush between the banks and the hedge funds. Just like the Great Depression, it will take years to work our way out of it if it happens, and there won't be a stock market to worry about either.
So it's time to forget the textbook theories that the market will always correct itself. Exceptional threats require exceptional remedies.
If I'm wrong about the outcome I'll be in good company, and I'll admit it.
I agree with just about everything you've said.
But the problem is this: I can almost guarantee you that what the US government will do will not solve the problem, nor ameliorate it and will probably, for all intents and purposes, make it worse.
And that is why I believe it's probably better to take the medicine now, like castor oil or any other purgative, and get it over with quickly than to have it drag on for ten years. Everyone believes we can avoid financial Armageddon if the government handles it right. What they don't realize is that THIS IS financial Armageddon.
Again, I sure as heck hope I am wrong, but I don't think I am.