It's been a crazy week to say the least. A day after the biggest sell-off since the Nasdaq bubble burst, we looked set for another volatile, yet down day until late day news that the Treasury Secretary Paulson was lobbying Congress for the creation of an entity that would buy bad loans from troubled financial institutions. The market rallied to one of its biggest gains since 2002.
As if that wasn't enough mania for one day, after hours comes word that SEC Chairman Cox has proposed a temporary ban on short-selling:
SEC Chairman Christopher Cox briefed Congress late Thursday of the agency's plans to take the extraordinary step of interfering with the market's regular functioning. Short-selling is a trading strategy of selling borrowed stock in hopes it falls and can be repurchased at a lower price.
The details of the SEC's measures are unclear. The ban must be approved by the commissioners, and there's no word on which stocks are covered or for how long it will be in
Now, to be fair, details are completely unclear right now. We have no idea of the magnitude of what's been proposed, and whether Congress would entertain such an idea. That said, the mere fact a discussion is even being had boggles my mind.
Who needs arteries when we have veins?
So what does this bloody analogy have to do with today's craziness? Any closed system only works if a) the constituent parts are functional and b) each of those constituent parts play a key role. I would argue (as most rational people would) that short-selling is an integral part of the securities industry.
Let's not confuse abusive, naked short-selling with what Cox is allegedly trying to curtail tonight. Short-selling is an essential component of a free market. How ironic is it that, at a time when liquidity is evaporating throughout the system, we're talking about removing a major component of the most liquid part of the capital markets (daily trading in listed equities).
Paul Kedrosky sums it up succinctly:
But even if we dismiss price efficiency, consider the practical consequences of making it impossible to short financials (and don't even get me started about disallowing all shorting): What happens, for example, if you're running a long/short quant fund with billions of dollars and hundreds of positions? Do you give the money back now that you can't trade the short side of your fund? Do you push all the short trades through ETFs? Do you abandon the entire financial sector? And who do you sue when your fund blows up because you're not sector neutral? Short-only funds are, of course, now, turned into commercial real estate companies.
An outright ban of short selling, even for a temporary time, makes so little sense I would normally be loathe to even acknowledge this kind of rumor. But based on what we've seen over the last week, nothing appears out of the realm of possibility.
Michael "Mish" Shedlock termed this the peak of insanity:
...Apologies offered for the séance prediction. At least I considered the options. Most did not. With that in mind, I cannot predict (nor can anyone else) when this manipulated rally will fizzle out, one can only state that it will.
Those looking for a global equities crash are likely to get it if this resolution passes, and in fact may get one whether it does or not. Such is the nature of intervention into the no longer free markets in light of the fact there is simply no such construct as "peak insanity".
So who needs arteries when we have veins? Anyone that wants to live another day.
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