Monthly Archives: September 2008

The actions of the SEC of banning short selling and forcing short sellers to publicly report their short positions are a disaster waiting to happen. The new rules will cause liquidity in the stock market to fall even more than it already has and will result in uncertainty at a time when we desperately need both.

Why?

Imagine you are a hedge fund manager or any large money manager and part of your investment strategy is to hedge to reduce risk. By banning short selling and more importantly forcing you to report your positions, you will effectively reduce your short selling or eliminate it, which apparently is the goal of the Treasury and the government.

But go back and imagine you are that hedge fund manager, and you cannot hedge. What do you do?

I think you have two options:

1) You reduce your long positions to reduce risk and exposure to the market

2) You buy commodities as a hedge

Or you do both. There is ABSOLUTELY NO WAY, you just keep your long positions and take on more risk. And further, you cannot report your short positions because people will try to squeeze you and even if that didn’t bother you, companies would see who was short them and they would freeze you out and not talk to you.

So, this guarantees less short selling, which will actually lead to less buying of stocks and more buying of commodities.

And by arbitrarily changing the rules with little or no warning for political reasons, this unsettles the market and causes more uncertainty.

So in one single stroke, the government has set up a situation of a loss of liquidity and a loss of confidence exactly when we need it most. So, I hope you enjoyed the big rally on Thursday and Friday. We got a nice two-day feel good short squeeze and then Monday’s back to reality lesson.

Who else has banned short selling and how did it work for them?

The last government to ban short selling before us was Pakistan. They banned short selling on June 23rd. The Karachi stock rallied 1,300 points in three days. What is the end result today? The Karachi stock market is down 26% in less than three months. That would bring the Dow below 8000, if we ended up with the same result.

And this is to say nothing about the awful $700 billion mortgage fund…

Say goodbye to the dollar rally and hello to even more dramatic swings in the markets, courtesy of the U.S. Government. Thanks for making the crisis even worse!

Howard Lindzon writes what I think is an excellent column on the forced selling and puking of stocks in the US and in Canada. Check it out:

Puking of Stocks

I wouldn’t pay attention to the short covering rally that the market experienced on Monday. And this rally may have some short term legs. But make no mistake about it, the government bailout of Fannie Mae and Freddie Mac has several negative implications for the economy, real estate and the stock market. Here are the main points:

1) The bailout should kill the dollar rally. Once foreigners start putting two and two together and realize that the government is on the hook for trillions of dollars of mortgages and could easily experience north of $300 billion in losses in the next three years, they will sell dollars. This makes our government’s budget even more shaky at a time that the government is being stressed by slowing tax receipts and increasing expenditures on medicare, social security and other social safety net spending.

2) As part of this plan, FNM and FRE will have to start reducing their portfolio with the goal of getting out of the market or being radically smaller. This will happen around 2010, but the market will anticipate this. This will force banks to keep more mortgages on their books or simply stop offering as many mortgages. This is yet another step in the de-leveraging the US economy will continue to go through and it is a huge negative for economic growth.

3) This bailout changes little for the average consumer who is being battered by lower home prices, heavy indebtedness and a rapidly slowing economy.

I understand the relief expressed by the market, but expect continued turmoil and tough times ahead for financial firms that will confront a higher regulatory burden, more fees from the government from such things as FDIC insurance premiums and dealing with keeping more loans on their books. The prospect for financial firms doesn’t look good for the next 3 to 5 years as the slow moving financial credit bubble gets unwound.