Saturday, September 20, 2008

U.S. Actions on the Markets

This was an unprecedented week in the markets (but isn't every week unprecedented?), with the US financial landscape forever changed with the bankruptcy of Lehman Brothers, the acquisition of Merrill Lynch by Bank of America and the US taxpayers' bailout of AIG, the world's largest insurer by assets. Only one word can be used to describe this: wow!

With the markets in turmoil, and financials falling precipitously Thursday morning, word spread of a government-sponsored plan to thaw the frozen credit markets with an RTC like entity (RTC was formed and funded by the government in the 1980s to buy assets of banks and sell them in the markets. It ultimately made the US taxpayer a tidy little profit). This was an incredibly bullish move for the markets, and investors were right to cheer this move as it will only benefit the world credit markets, and prevent the world from falling into a severe depression, and destroying tremendous value in the markets. This plan was announced later Thursday evening in a bipartisan news conference.

While I cheer the moves of the Treasury Secretary Paulson, along with Bernanke and US Congressional leaders, I think that the SEC has overstepped their bounds. The SEC thought it would be wise to ban all short selling on 799 financial stocks (including many that I own). By banning short-selling, essentially we have prevented one of the most efficient corrective measures in the marketplace - we as investors can sell shares of stocks we believe are overvalued to bring them down to fair value. The SEC has blatantly allowed short selling on all stocks at all times, even as they fall (selling on "downticks" - when a stock's price is falling on the exchange), and now, instead of reimplementing the "uptick" rule (that was first implemented after the Crash of '29), they eliminate the practice altogether? This socialistic move will not prevent the declines in the marketplace for financial stocks, and really is a targetted move against hedge funds - it's funny how politics gets in the way of free market capitalism. The US (and UK, I may add) took a giant leap backwards with the full ban of short-selling on financial stocks, and this will not ultimately stop the declines in the marketplace.

A final note: what was happening to financial stocks was not unhealthy. It is important to note that banks were lending callously and without regard to risk when they sold mortgages to unworthy customers. The investors in these banks should be punished for reckless abandonment of risk-reward modelling. While the world governments need to protect everyone from complete collapse of the financial system (by saving those "too big to fail" like AIG), they should not stop the markets from running effectively. There is always collateral damage in the marketplace - let the system cleanse itself, even if it involves a little hemorrhaging. We will see in the weeks following October 2nd whether the short selling ban really "saved the death spiral".

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