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The SEC "solves" its screw-up by screwing up again

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September 19, 2008 – Comments (11)

Wow what a morning.  There's lots of news out there.  I have been trying to get my hands around what has happened and what it all means.  First I will talk about what a disgrace the SEC is.  I am completely disgusted with Chris Cox and his friends there.  They all should be fired, without packages immediately.

I somewhat understand the need for the temporary ban on short selling, but it should have never gotten to this point.  Let me explain. 

Yes, many of the companies that the government has had to bail out or that have gone bankrupt were in bad shape and may have eventually gone belly-up anyhow...but hedge funds were accelerating this process to hyper-speed.  Here's how they were doing it.  They started by floating rumors out there and buying up Credit Default Swaps on companies.  When traders and the idiotic ratings agencies (who are as much to blame as anyone for this mess) saw the CDS prices explode they said "wow, this company must really be in trouble" and its stock began to freefall.  At the same time that the funds were buying up the CDSs, they were shorting the he-two-sticks out of the company's common stock...accelerating its decline.  Hedge funds were going through and picking off companies one at a time.  It would have continued and it was creating massive panic, so something had to happen.  Unfortunately as usual, the government went too far.

The SEC already had rules on the books to prevent the sort of "naked" short selling that has been absolutely hammering stocks...yet it never enforced them.  Furthermore, the SEC eliminated the "uptick" rule so now hedge funds can continue to pound on stocks hammer them into oblivion.  If the uptick rule had remained in place and the naked shorting and rumor starting rules been actually enforced this short of rapid targeted destruction of individual companies would not have happened. 

Instead of fixing its mistakes, now the SEC has gone way too far in the other direction by banning the short selling of 799 financial stocks (why couldn't they find one more company and just make it an even 800).  Where do we live again?  Russia, where they can just close the market arbitrarily for days at a time.  This is the United States of America and we are supposed to have free markets.  Shorting is a necessary part of that...within reason.  If the SEC had taken the steps that I outlined above we would have never gotten into this mess so quickly.  What does the short selling ban accomplish anyhow?  Anyone who really wants to short these companies will just wait until the ban is over and then hammer away.  Good greif.  These companies still have all sorts of problems.  Oh yeah, that's right the government is going to buy all of their bad paper.  That should fix things...for them but not the citizens of this country.  Hopefully later I will talk about the governments mind-blowing purchase of everything on Earth and its implications for the taxpayer, the economy, and the U.S. dollar.

Oh well, I wasn't short anything anyhow so it's nice to see some green in my portfolio today.

Deej

11 Comments – Post Your Own

#1) On September 19, 2008 at 10:10 AM, dwot (71.65) wrote:

It is a disaster...

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#2) On September 19, 2008 at 10:11 AM, TMFEldrehad (99.99) wrote:

Yes, many of the companies that the government has had to bail out or that have gone bankrupt were in bad shape and may have eventually gone belly-up anyhow...but hedge funds were accelerating this process to hyper-speed.

I in no way profess to be an expert on SEC rules, so hopefully I can learn something here -- but I honestly don't see how hedge funds could have sped-up this process via short selling.

Companies go bankrupt for one simple reason - insufficient cash in the corporate coffers to pay the bills.  All the short-selling in the world doesn't change that.  Sure, it drives stock prices down, that I understand -- but that money is being traded between external shareholders with none of it flowing into, or out of, the corporate coffers.

Sure, if a company was considering a secondary offering of shares a depressed share price makes that more difficult, but this is an indirect impact.  In terms of short-sellers driving companies into bankruptcy, I just don't see it.

Again, though, I could be missing something.

Regards,

Russell (a.k.a. TMFEldrehad)

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#3) On September 19, 2008 at 10:11 AM, TMFEldrehad (99.99) wrote:

Yes, many of the companies that the government has had to bail out or that have gone bankrupt were in bad shape and may have eventually gone belly-up anyhow...but hedge funds were accelerating this process to hyper-speed.

I in no way profess to be an expert on SEC rules, so hopefully I can learn something here -- but I honestly don't see how hedge funds could have sped-up this process via short selling.

Companies go bankrupt for one simple reason - insufficient cash in the corporate coffers to pay the bills.  All the short-selling in the world doesn't change that.  Sure, it drives stock prices down, that I understand -- but that money is being traded between external shareholders with none of it flowing into, or out of, the corporate coffers.

Sure, if a company was considering a secondary offering of shares a depressed share price makes that more difficult, but this is an indirect impact.  In terms of short-sellers driving companies into bankruptcy, I just don't see it.

Again, though, I could be missing something.

Regards,

Russell (a.k.a. TMFEldrehad)

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#4) On September 19, 2008 at 10:25 AM, rd80 (98.42) wrote:

Another explanation of how they can use CDS in conjunction with short selling here.  Rating agency procedures also need to be reviewed; when the CDS prices are bid up, the agencies include that in the risk models.  If a down grade is triggered, the company needs to raise more capital and it spirals from there. 

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#5) On September 19, 2008 at 10:48 AM, TMFDeej (99.40) wrote:

Thanks for reading, Russell.  The way that hedge funds speed up the process of a company going bankrupt is they destroy clients' confidence in it.  Let's take Lehman for example.  The people who did business with Lehman saw what was happening with its stock and they decided that it would be safer to do business with someone else who was in better shape.  No clients means no revenue to service debt and fund operations.

At the other end of the spectrum we have AIG.  The massive purchasing of CDS and shorting of stock convinced ratings agencies that something was wrong with it.  This caused the inept ratings agencies to downgrade or at least consider downgrading it.  The downgrade triggered clauses that force AIG to have more collateral which it was unable to obtain when fear rules and the credit markets are seized up.

These are just two examples of how shorting sped up the destruction of companies.

Deej 

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#6) On September 19, 2008 at 10:51 AM, TMFDeej (99.40) wrote:

Thanks for reading, Russell. The way that hedge funds speed up the process of a company going bankrupt is they destroy clients' confidence in it.

Let's take Lehman for example. The people who did business with Lehman saw what was happening with its stock and they decided that it would be safer to do business with someone else who was in better shape. No clients means no revenue to service debt and fund operations.

Another example is AIG. The massive purchasing of CDS and shorting of stock convinced ratings agencies that something was wrong with it. This caused the inept ratings agencies to downgrade or at least consider downgrading it. The downgrade triggered clauses that force AIG to have more collateral which it was unable to obtain when fear rules and the credit markets are seized up. These are just two examples of how shorting sped up the destruction of companies.

Deej

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#7) On September 19, 2008 at 11:50 AM, Tastylunch (29.23) wrote:

I agree 100% Deej. The SEC is a joke.  They had plenty of time after Bear to implement real worthwhile measures in/on the CDS markets, Hedge funds & elsewhere and chose not to. Their horrific incompetency is costing us all.

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#8) On September 19, 2008 at 1:12 PM, GS751 (27.66) wrote:

The government just needs to keep their hands out of the economy.

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#9) On September 19, 2008 at 2:36 PM, CBeeks1984 (< 20) wrote:

Look on the bright side. AIG stock today was up $1.35 per share. The U.S. Government owns 80% of AIG stock which I am told equates to a gain of $15 billion. At this rate, Americans will never have to pay taxes again. Ain't socialism wonderful.

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#10) On September 21, 2008 at 3:47 AM, awallejr (83.83) wrote:

The Gov't WAS keeping it's hands out, that is why this whole mess occurred.

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#11) On October 07, 2008 at 7:30 PM, Oraclepicks (< 20) wrote:

putting a blame on short selling is ridiculous. the blame lies with the principle reason why predicting a stocks downfall is certain

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