Thursday, September 18, 2008

Short-Selling: what it means for the market.

PS - I have no idea why, but Blogspot has backdated my last two posts to yesterday, Thursday. These top two posts are for Friday, 19 September, 2008. Shalom!

Here is an article you really should read, which explains pretty well what effect the new "short-selling" rules will really have on the stock market.

The Oil Drum
No Naked Short Selling=>No Short Selling at All=>No Future Energy?
Posted by Nate Hagens on September 19, 2008 - 10:05am

In an amazing (and as yet unconfirmed) development tonight, the SEC has announced a temporary ban on ALL short selling. In the 100 or so posts I have put on theoildrum in the past 3 years, I've (mostly) included my opinions in the conclusion only, and primarily have offered evidence and datapoints in the main article for the reader to form their own interpretations. Tonight I will 'temporarily' diverge from that pattern. If ALL short selling is truly banned, whether it be for a week, a month or a year, the capital markets as we know them will cease to function, which would cause a clear and present danger to the security of our energy future. (UPDATE at end of post 9/19 06:30 CDT)...

...Though I spend much of my free time trying to kickstart a national energy discussion and suss out ways of taking at least baby steps away from our global conspicuous consumption carrot, I still maintain close friendships with many of the wall street crowd. After seeing this news, I have since talked to about 10 people. Here is an aggregate of opinions and reactions. The predictions are my own.

First of all, we simply CANNOT halt all short selling. The public (Hillary Clinton and Chuck Schumer) position is that short selling was the root cause for the demise of Bear Stearns and Lehman Brothers and why Morgan Stanley and Goldman are currently on the ropes. The truth is that SOME short sellers use unscrupulous methods to make short selling stocks a self-fulfilling prophecy, and thereby profit. The vast majority of short sellers however act as cleaner-fish, policing the stock market for crooked management, unethical practices and bad business models. I have been told that what is underway is a large scale witch hunt that in the next few weeks will show the public some 'very well known' names ending up in jail. But just as pursuing ethanol to wean us off of oil, and pursuing oil speculators to blame oil price rises on, eliminating ALL short sellers in order to punish a few bad eggs will have wide boundary unintended consequences.

To wit: what would happen if the SEC continues down this path:

a) an enormous short covering rally. If there were no grandfather clause (meaning existing shorts would have to cover), we could see all time highs in stock market within weeks. I expect if this rule goes into effect there will be some clause preventing this and that only financial stocks will be censored- but who knows?

b)once all the shorts have covered, the long-only hedge fund managers would say 'thank you very much' and sell their (now vastly overvalued) holdings in Corus Bankshares (81% of float short), Downey Financial (69% of float short), etc. at valuations far higher than the underlying businesses deserve.

c)once the up/down purification was complete, we would have far fewer market participants, much less liquidity, and much less trust in our markets, without having any impact at all on the fundamentals of the companies involved.

d)changing rules overnight like this is beyond a Monty Hall campaign. It is the beginning of the nationalization of industry, which started with the Bear Stearns bailout and has continued with various market interventions. Until now I thought financial markets would be the last thing to go - not the first - if this rule goes through I am not so sure...

...In sum, I will close this rant from a mild mannered guy with this thought. We have entered new territory (obviously). Scary territory for many who have become accustomed to a certain way of life, and have not yet thought through the possible paths we might collectively go down in the coming years. Ultimately this is a story about energy - lower energy surplus all around makes people more likely to swing for the fences. While swinging for the fences inevitably some are going to strike out. The umpires at the game should have the wisdom and guts to call those players 'out' while letting the other athletes continue playing the game. In a perfect world, some of the best athletes, who have been pursuing inclusive fitness defined in our era by pecuniary terms, will migrate towards an area that urgently needs creativity, passion, tenacity and follow-through - the local and global scaling of renewable energy infrastructure that we will need as fossil fuels decline in coming decades. Without functioning financial systems, and the trust of large capital players, the energy future we are attempting to change, cannot even get started...

...(**UPDATE 6:40 am Well, , they did it, though as expected a watered down version limited on the surfaceto only financial stocks. Other wrinkles will require short sellers to publicly disclose their positions and easing restrictions on securities issuers repurchasing their securities. But the damage is done I am afraid. Who is going to want to short stocks now, even non-financial ones, at risk of future rule changes at any point (for example, if we had a 40% selloff in plastics stocks due to deteriorating fundamentals in the plastics industry)? Expect massive lawsuits from state class action from retirees invested in SKF as a hedge - expect strong language as analysts on CNBC and other network that understand the implications of this move fight back. This will cause the SEC to further backpedal on this rule, perhaps publicly stressing that current shorts don't need to cover, etc..

What the SEC fails to realize is that there will be a mini-exodus from the business in the next 2 weeks before quarter end and a mass exodus from the business by year end due to lack of confidence, which up til now Paulson and crew continued to convey to the larger players. The end result now will be far worse than some of our banks going under (which will happen anyways due to deteriorating company fundamentals) - the end result will be a lack of confidence in the financial system. Some late night calls and I understand they are really after 2-3 high profile hedge funds and people are going to jail - but what a cost... While I was in the near term peaking camp due to rising marginal costs, Peak Oil is now a thing of the past. There will never be a year where we produce more than we do in 2008, and if things fall fast, then 2008 still may not catch 2005. The lack of confidence in our financial system will eliminate any chance we had of offsetting depletion with new production and new technology. You can bank on it...

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