Tuesday, September 30, 2008

Quote of the Day

The SEC's ban on short selling is a perfect illustration of the dangers of regulators taking a cartoon view of the world, where evil villains are responsible for all the chaos in fair Gotham. In their monomaniacal focus on the manipulative potential of short selling, Cox and his his minions have completely overlooked its benefits, and implemented policies that have inflicted substantial collateral damage on other portions of the financial market, including parts of the market that could facilitate fixing problems at the institutions allegedly protected by the regulations–banks.

This is particularly tragic given that the rationale for the policy is based on anecdote–to put it as charitably as possible. Remember what George Stigler said: The plural of “anecdote” is not “data.”

~Streetwise Professor

7 Comments:

At 9/30/2008 9:53 AM, Anonymous bornskeptic said...

I agree that banning shorting was draconian, but the ability of shorts to push leveraged companies into black hole equity spirals of death needed to be stopped. The naked shorting had to go, and never should have been allowed back in after Aug 12, when the SEC's emergency order ended. After that is when we had Fannie, Freddie, Lehman and AIG go down the tubes. Maybe just banning the naked shorting and bringing back the uptick may have been sufficient.

 
At 9/30/2008 9:56 AM, Anonymous bornskeptic said...

Oh, almost forgot, they should have instituted some disclosure rules too for short positions (I think they may have done this). Made no sense to me to allow huge hedge funds to build very big short positions in stealth mode, whereas they can't do that on the long side. And, the argument about that limiting shorts ability to talk to the management shouldn't really apply anyway in the world of post reg FD.

 
At 9/30/2008 12:09 PM, Blogger bobble said...

agreed.

naked short selling seems problematic. but otherwise, the ban is purely cosmetic.

LOL, china just approved short selling to help revive their stock market. article

 
At 9/30/2008 1:59 PM, Blogger the buggy professor said...

1) That's well put, bornskeptic: A confidence crisis in financial markets --- which can lead in contagion like way to an upward spiral of "sauve qui peut" by creditors and uninsured depositors at any risky financial institutions) --- can spread with startling rapidity world-wide . . . a psychological matter that economists are generally ill-suited to analyze. (Correction: unless those economists, maybe a handful, have studied what happened in the US and global economy after the stock market crash of 1929 to our credit- and larger financial system.)

……
2) What happens is that creditors and those uninsured depositors fear --- once doubts lead to initial attack-like cash-ins at those institutions --- they will lose their principal and hence start shoving and elbowing their way toward the front to withdraw before a collapse occurs.

And yes, it does not matter necessarily --- once these spiraling contagion-driven fears occur --- what the actual financial soundness of an institution might be: a commercial bank, an investor bank, a credit union, a hedge-fund, a foreign government's dollar, yen, and euro reserves --- think of the 1997-98 financial meltdown in Asia (which of course was not at all, no! no!, an augury of what footloose capital in the trillions of dollars might do suddenly here or in Europe) -- or brokerage houses or . . . well, the list might go on.

....

3) And yes, you're also right that leverage has dangerously exploded in this era of unregulated or poorly regulated financial hanky-panky: the entire derivative market beyond all regulation, with additionally very poor risk-management by financial firms of all sort.

Hence investment banks, whose leverage was about 10 or 11:/1 were given the green light at the SEC in this decade to triple that ratio, have now found their numbers reduce from 5 giants to 2 . . . the latter staggering, with a possibility of survival thanks to Federal Reserve encouragement and William Buffett's stock investments in one of them (Goldman Sachs) and a British bank's in the other.

.....

4) More generally, the utter failure of the existing regulatory agencies --- first and foremost the SEC --- to reign in this explosive growth of leverage, most of it based on high-risk assets (housing) and then turned into financial paper, slicked, diced, and repackaged as derivatives, was set out at length last week by the Inspector General of the SEC.

And Chris Cox --- brought in by President Bush to head the SEC when the previous chairman, William Donaldson, actually sought to regulate hedge funds, mutual funds, and more generally the now ever more complex and elusive financial system in general, was forced to resign by Congressional Republican wrath --- admitted after the Inspector General's report that he had been negligent: financial markets couldn't, as free-market enthusiasts believed (and many still do), regulate themselves. They need, instead --- and with vigor --- to be regulated by rule-based governmental regulators and the Federal Reserve.

.....

5) For what it's worth, I have discussed this earlier today in a couple of posts at the Marginal Revolution, the web site of Tyler Cowan --- Mark Perry's former Ph.D. superviser. Go here if you want:

http://www.marginalrevolution.com/marginalrevolution/2008/09/the-problem-is.html#comments (copy and paste in your brower address bar)

.....

Michael Gordon, AKA, the buggy professor

 
At 9/30/2008 2:35 PM, Blogger Dave Narby said...

FOR YEARS investors have been screaming bloody murder about naked short selling, ASKs being made below BIDs in low volume stocks, etc.

Finally when the chickens come home to roost, they don't just decide to ENFORCE THE F*CKING LAWS ON THE BOOKS, BUT PASS MORE LAWS PROHIBITING (THE ALREADY ILLEGAL) NAKED SHORTS - THEN BAN SHORT SELLING ALTOGETHER!

Guess their college buddies in finance finally started to feel the pinch!

This is corrupt and rotten to the core.

The head of the SEC should be FIRED, and THE LAST 10 YEARS OF SEC HEADS SHOULD BE INVESTIGATED FOR FRAUD, ABUSE AND CORRUPTION.

 
At 9/30/2008 4:03 PM, Anonymous qt said...

"FOR YEARS investors have been screaming bloody murder about naked short selling"

Correction: small investors have been complaining about naked shorts.

 
At 10/02/2008 7:31 AM, Anonymous Anonymous said...

If mark to market rules are arbitrarily-restrictive accounting practices does that mean the margin requirements are arbitrarily-restrictive accounting practices? If not please explain the difference to me.

 

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