First the president, then the head of the Securities and Exchange Commission. It's good to hear from these guys. The good news about Christopher Cox's op-ed in The Wall Street Journal is that he was somewhat more articulate than President Bush, though less diagnostic. If you read Cox carefully, he's basically arguing that the crisis at hand was the result of unreliable information on firms generated by "manipulators"; Bush at least fingered "fancy financial instruments." More specifically, Cox was defending his move to restrict naked shorting in a number of financial stocks. The SEC chief insists a) he's got nothing against shorting, b) he's not really too concerned with naked shorting, but c) "abusive naked shorting" is a real threat that has to be stomped out, although he doesn't think it's really been a huge problem yet.
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Beside being clear as mud, this offers up a new taxonomy. Cox is really dancing around a mystery to this tempest, which I touched on in a post Tuesday: Why has the SEC tolerated naked shorting, which would appear to be cheating (no borrowed stock underlying the short) and which would appear to have little economic benefit, until now? I did receive one comment to that post that did argue that hedging programs require shorting, and that there's often not enough time to insure the stock is actually available. This raises other issues, but it does provide an economic rationale -- as opposed to a speculative rationale -- for the practice. But Cox doesn't go there, arguing instead that the SEC only cares about when "manipulators force prices down far lower than would be possible in legitimate short-selling."
Clear? Hardly. How can the SEC make this determination in these huge, high-volume, fast-changing markets? Discriminating between manipulative or abusive naked shorting and the all-American version is like separating a manipulative rumor from a legitimate rumor. It goes to state of mind, which is a very murky, even sinister, place to poke around.
But there's more. "The emergency order is not a response to unbridled naked short selling -- which so far has not occurred. Rather it is intended as a preventative step to help restore market confidence at a time when that is sorely needed." Bravo. But does that mean that Bear Stearns Cos. was not victimized by shorts or naked shorts? That Lehman, Fannie or Freddie had no beef? Hmmm, if that's the case, then what's been going on out there? Maybe everybody was drunk. - Robert Teitelman
Comments
"Why has the SEC tolerated naked shorting, which would appear to be cheating (no borrowed stock underlying the short) and which would appear to have little economic benefit, until now?" Simple, trading, legal or otherwise is liquidity, and to guage the US Capital markets the regulators are fixated on liquidity.
Today the SEC is perplexed on what is of greater importance, the right for any investor to invest (instant liquidity) vs. the right of those already investor to fair market practices (investor protection). Until now, the former was dominant and those with the necessary capital could take advantage of the latter because of it. There must be a compromise between liquidity and investor protection and with todays operating capital that compromise must be a pre-borrow on short sales and a guaranteed settlement on all trades. The buyer in a trade has the same right to investment protection as that individual hedging a position by shorting first and worrying about settlement later.