Tuesday, March 17, 2009

Short selling "price test rules" are controversial again


Back in the 1990s, among “amateur” day traders, “selling short” was talked about as a kind of entertainment, like going to Vegas without leaving your computer (when broadband wasn’t as well established). But on Wall Street and in pondering the current crisis, it’s dead serious stuff.

The media reports that the SEC wants to consider (when it meets April 8) restoring the “uptick rule” (as part of “short sale price test rules”). Today (March 17, 2009), Binyamin Applebaum and David Cho have a Washington Post Business Section (soon to go!) story on p D1, “Betting on Bad News: Short Sellers Again Targeted as Bank Shares Stay Low”. The link is here.

Short selling on financial stocks was stopped for about a month after the house of cards collapsed in September 2008, propelling us into a “brave new world”. Critics still say that it is harmful.

I had a conversation with a someone employed by a “moderate” think tank Sunday afternoon at a reception, about all the bailouts and the general impression by many like John Stossel that they’re “bull”. He said that the basic problem is that Wall Street insiders could construct financial products that even professional investors could not understand. I said, how can you insure something (like a CDO) that you don’t have insurable interest in – and have no collateral for – how could that even have been legal. He said, maybe it shouldn’t be. But it’s a transparency problem, not an insurance (anti-selection) problem (CDS) in the usual sense. Yet, it seems that Wall Street created products that short sellers had every short term incentive to destroy, however indirectly. Jim Cramer was saying that already in August 2008. Generally, with more transparent securities and companies, short selling provides a healthful counter-incentive to prevent securities from becoming over valued.

Of course, with some our past bubbles, as with the Dot com bubble, short selling didn’t control irrational exuberance. The Bubble and bust were probably more a social phenomenon. We just couldn’t predict reliably how people would behave in a world with a new topology.

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