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2008-09-20 Home Front Economy

Unintended Consequences From Short Selling Ban

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Posted by badanov 2008-09-20 07:49|| || Front Page|| [1 views ] Top

#1 "It is going to impact the profitability of prime brokers, there is no question of that," he warned.
My heart is breaking....not!

Posted by tipper 2008-09-20 12:19|| 2008-09-20 12:19|| Front Page Top

#2 Naked shorting driven by false rumors started by employees of brokerages and the naked shorters themselves is even more destructive.

Posted by Sockpuppet of Doom 2008-09-20 15:37|| 2008-09-20 15:37|| Front Page Top

#3 Naked shorting driven by false rumors started by employees of brokerages and the naked shorters themselves is even more destructive. Prove it. Post citations & urls to document your assertion.

Posted by Anguper Hupomosing9418 2008-09-20 17:02|| 2008-09-20 17:02|| Front Page Top

#4 SPOD: Naked shorting driven by false rumors started by employees of brokerages and the naked shorters themselves is even more destructive.

Lehman, Bear Stearns and AIG weren't driven out of business by false rumors. Potential buyers looked over their books in detail and saw so much toxic waste that they balked. Again the problem is that they're insolvent by some huge margin (liabilities >>>>> assets). This ban on shorting is simply a government-mandated transfer of cash from people who were right and had puts expiring on Friday or short positions in hard-to-borrow stocks to the people on the other side of their trades.

If these companies were worth anything, don't you think Warren Buffett would have stepped in and bought them out? T. Boone Pickens? Foreign sovereign funds? The shorts did not drive them out of business - their balance sheets did. The bottom line is that their demise had everything to do with their bad bets and excessive leverage, and nothing to do with short selling. All that short sellers - and stockholders liquidating their holdings - did was recognize their impending closure. The idea that short sellers prevent companies from continuing to exist is wrong. There are plenty of large pools of capital out there - including pools of capital owned by short sellers, whose objective is to make money rather than hew to any particular method of trading. If it made sense to acquire companies like AIG, Lehman and Bear Stearns, these pools of capital would already have pounced.

Lehman's market cap is now around $1b. Why hasn't someone swooped in to buy the company and pay off the creditors? Why is Lehman's debt trading at $0.30 on the dollar? Are short sellers shorting their debt as well? Are bond buyers so irrational that they won't buy debt in cases where they think repayment is certain for $0.30 on the dollar? Maybe the reason is that they don't think repayment is such a sure thing.

Posted by Zhang Fei 2008-09-20 17:15|| http://timurileng.blogspot.com]">[http://timurileng.blogspot.com] 2008-09-20 17:15|| Front Page Top

#5 Here is the official SEC announcement of the emergency halt order:

The Securities and Exchange Commission on Sept. 17 took several coordinated actions to strengthen investor protections against "naked" short selling. The Commission's actions will apply to the securities of all public companies, including all companies in the financial sector. The actions are effective on 2:01 a.m. ET today.

"These several actions today make it crystal clear that the SEC has zero tolerance for abusive naked short selling," said SEC Chairman Christopher Cox. The new rules, adopted on an interim final basis, require short sellers and their broker-dealers to deliver securities by the close of business on the settlement date three days after the sales transaction date and impose penalties for failure to do so. If a short sale violates the close-out requirement, SEC will prohibit any broker-dealer acting on the short seller's behalf from further short sales in the same security unless the shares are not only located, but also pre-borrowed. The commission also eliminated the options market maker exception from the close-out requirement.

Cox had plenty of realtime data on the shorts being sold. Even without knowing if any particular position was covered, he could easily see that massive naked short selling was occurring - and given that computerized trading is done nearly always based on technical indicators, that was coming very close to causing a total meltdown in the market on Wednesday.

Cox was looking at far more than the beatdown of Lehman stock. There were a lot of other banks whose stock values were driven down as much as 80% in a 2 hour period of trading at the height of the panic on Wednesday. As a result, there was a period on Wednesday when it would have literally been impossible for most banks in the US to meet liquidity requirements. The entire credit circulation system was in serious danger of being cut off by the tourniquet of naked short selling that day.

Posted by lotp 2008-09-20 17:49|| 2008-09-20 17:49|| Front Page Top

#6 Lotp: I'm nearly as ignorant of the market process as a hog is about the sabbath. Can you explain the down side of just letting the entire wad collapse vs the "W" bail out?

Posted by Besoeker 2008-09-20 17:53|| 2008-09-20 17:53|| Front Page Top

#7
Short version: the daily exchanges of credit that keep banks open would have been cut off. Not just to the Lehmans of the world, but to your local bank.

Which would have prevented them from doing things like meeting their obligations for cash to small and medium sized businesses that typically generate working capital from the banks, using their inventories and/or receivables as collateral.

Which would bring those businesses to a halt, with the result that they would lay off workers and stop ordering materials ....

Meanwhile, the banks themselves would have had to shut due to the liquidity required by regulation. Which would have caused a serious collapse of the dollar, of international financial circulation and quite possibly a global depression.

No exageration. There are that many international financial institutions who drank the coolaid of packed subprime mortgages or derivatives based on them.

Posted by lotp 2008-09-20 17:55|| 2008-09-20 17:55|| Front Page Top

#8 Got it! Thanks.

Posted by Besoeker 2008-09-20 17:59|| 2008-09-20 17:59|| Front Page Top

#9 Cox had plenty of realtime data on the shorts being sold. Even without knowing if any particular position was covered, he could easily see that massive naked short selling was occurring - and given that computerized trading is done nearly always based on technical indicators, that was coming very close to causing a total meltdown in the market on Wednesday.

We have had meltdowns in the market before. The Dow fell 23% in 1987. What we saw on Wednesday was a 5% drop. It was many things, but a meltdown it was not.

Posted by Zhang Fei 2008-09-20 18:01|| http://timurileng.blogspot.com]">[http://timurileng.blogspot.com] 2008-09-20 18:01|| Front Page Top

#10 By liquidity do you mean capital requirements which are driven by the stupid mark to matrket rules?

Posted by Nimble Spemble 2008-09-20 18:07|| 2008-09-20 18:07|| Front Page Top

#11 lotp: Short version: the daily exchanges of credit that keep banks open would have been cut off. Not just to the Lehmans of the world, but to your local bank.

Stock price collapses don't crush banks. Insolvency (debts > assets) does. What Paulson is trying to engineer is a situation where busted banks can raise new capital to avoid bankruptcy by issuing new stock. The problem with this strategy is that investors know that in the absence of short-sellers, these prices are cooked/inflated. Nobody trusts the valuations. (This is why the Chinese market remains at 1/3 of its peaks despite government exhortations and a prohibition on shorting). If stock prices are going to crash anyway and stockholders are going to get the shaft, why is Paulson doing what he's doing? Probably as a favor to his friends on Wall Street - they can survive recapitalizations via stock issues (if they manage to carry them out successfully), but they'll be turfed, in the event of bankruptcy filings, in favor of new management. What happens to stockholders who subscribe to these issues is not Paulson's problem - after all, it is written (of the brokerage industry) - "Where are the customers' yachts?"

Posted by Zhang Fei 2008-09-20 18:15|| http://timurileng.blogspot.com]">[http://timurileng.blogspot.com] 2008-09-20 18:15|| Front Page Top

#12 I think I agree, ZF, that this bailout is an effort to help bankers and not depositors or the economy. Bankers should be hung out to dry with their shareholders.

Posted by Nimble Spemble 2008-09-20 18:18|| 2008-09-20 18:18|| Front Page Top

#13 Heres another thought. Lehman had huge stock option programs for its senior executives. In the past four years, Lehman bought back $6.5b in stock in order to pump up the value of their stock options. If Lehman had that $6.5b last week, would it have folded? I dont know. But having kept that cash would have increased Lehmans shareholder capital by almost 1/3. Should companies with lavish executive stock option programs be allowed to buy back stock? Now thats a question thats worth pondering, because it directly affects the solvency of the companies that do the buybacks.

Yet another question - is Paulson doing this ban on short selling to protect the massive stock option holdings of his friends and ex-colleagues at the big banks?

Posted by Zhang Fei 2008-09-20 18:23|| http://timurileng.blogspot.com]">[http://timurileng.blogspot.com] 2008-09-20 18:23|| Front Page Top

#14 By liquidity do you mean capital requirements which are driven by the stupid mark to matrket rules

Capital requirements are one part of it. I'm not at all sure I agree that mark to market rules are stupid, but leaving that aside for the moment, there were other liquidity issues as well.

In particular, given the free for all panic in financials (not the whole market, ZF, but in banking-related instruments in particular) even banks in relatively good position were finding that they could not borrow the usual very short term (overnight, mostly) funds they rely on. Those funds are what enables them to offer low credit card / loan rates, among other things, because they don't have to keep more cash on hand than needed by borrower demand each day.

It was the imminent freeze up of that funding that threatened to bring the banking system to a halt. The Federal Reserve loosened overnight borrowing requirements, but that alone wasn't enough to halt the unraveling.

And if that had happened, we would have been looking at a lot more than a 5% drop in the DOW. But in any case, it wasn't the DOW that was the immediate concern - it was what was on the verge of spreading throughout the national and international banking systems that caused Cox to halt the short selling in financials.

Which is exactly what the SEC is supposed to do: ensure orderly markets and, in rare instances when a market ceases to be orderly, to halt trading. In this case they halted only what they had to to stop the panic/greed attack, i.e. the massive naked short selling of financial instruments and bank equities that was spinning out of control on Wednesday.

Those who say no such danger existed need to back that up, big time -- and to present a credible case for how exactly they have access to the data to do so. The SEC has sophisticated tracking systems that monitor in real time what is happening in the markets - information no one else has in aggregate or in total detail. They did not take this action lightly or to bail out buddies - unless everyone in this country is their friend.

Posted by lotp 2008-09-20 18:53|| 2008-09-20 18:53|| Front Page Top

#15 This WSJ article summarizes how close we came to some serious disaster on Wednesday. Excerpt:

When government officials surveyed the flailing American financial system this week, they didn't see only a collapsed investment bank or the surrender of a giant insurance firm. They saw the circulatory system of the U.S. economy -- credit markets -- starting to fail.

Huddled in his office Wednesday with top advisers, Treasury Secretary Henry Paulson watched his financial-data terminal with alarm as one market after another began go haywire. Investors were fleeing money-market mutual funds, long considered ultra-safe. The market froze for the short-term loans that banks rely on to fund their day-to-day business. Without such mechanisms, the economy would grind to a halt. Companies would be unable to fund their daily operations. Soon, consumers would panic.

RTWT

I'd like to remind sceptics that here at Rantburg we had a couple people urging us to withdraw cash - several $1000 per person, as I recall ....

Posted by lotp 2008-09-20 19:44|| 2008-09-20 19:44|| Front Page Top

#16 The actual emergency order press release direct from the SEC dated 19 Sept 2008 is here. It does not mention "naked short selling."
The SEC's prior order of 17 Sept 2008 is here. That's the one that mentions NSS, but that is not the order that protected the 799 institutions against any kind of short-selling.

Posted by Anguper Hupomosing9418 2008-09-20 20:22|| 2008-09-20 20:22|| Front Page Top

#17 They're totally unconnected with one another, no doubt.

Posted by lotp 2008-09-20 20:28|| 2008-09-20 20:28|| Front Page Top

#18 lotp - distinctions like this are important. I am still waiting for anyone to post cites and urls documenting the epidemic of NSS you referred to earlier.

Posted by Anguper Hupomosing9418 2008-09-20 20:36|| 2008-09-20 20:36|| Front Page Top

#19 I'd like to remind sceptics that here at Rantburg we had a couple people urging us to withdraw cash - several $1000 per person, as I recall ....

We are in your internetz, spreading "Withdraw your Cazh" rumorz...

Posted by Abdominal Snowman 2008-09-20 20:48|| 2008-09-20 20:48|| Front Page Top

#20 Meanwhile, back at the SEC:
"The Commission staff is recommending to the Commission a modification to its order prohibiting short selling in securities of specified financial firms. This modification would extend, for the life of the order, the exemption for hedging activities by exchange and over-the-counter market makers in derivatives on the securities covered by the order. "
Had to really dig to find this one. It was not referenced at the SEC's main web page, I found it cited in another financial article.

Posted by Anguper Hupomosing9418 2008-09-20 21:20|| 2008-09-20 21:20|| Front Page Top

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