Naked Hunting Season to Resume Tomorrow

In a few hours, the SEC will lift its ban on short-selling of 900 stocks. That is well and good, except that it appears that hedge funds will also be permitted to resume abusive naked short selling – offloading stock that they do not possess in order to dilute supply and drive down prices.

Given that naked short selling precipitated the collapse of Lehman Brothers, which triggered global panic, it seems fair to say that the resumption of naked short selling could precipitate the collapse of another big bank, which will fuel still more panic, and then we will really be screwed.

Say what you will about Lehman’s balance sheet, that company was not going out of business until its stock price hit rock bottom, making it impossible to raise capital, and triggering a run on the bank. The stock price hit rock bottom because it was bombarded by naked short selling and false rumors.

Some financial media have been cheering the imminent lifting of the short-selling ban. According to these journalists, the ban did not prevent the stock market turmoil of the last couple weeks. Therefore, lifting the ban should not make things worse and short-selling is good for the markets and blah blah blah.

The media never cease to astound on this issue. The fact that markets have been bad does not mean they wouldn’t have been a whole lot worse without the ban. And if short-selling is good for markets, this is fully besides the point. The point is that naked short selling is most definitely not good for the markets, and, as of tomorrow, that very not-good-for-the-markets activity is going to be allowed to resume with the full acquiescence of the SEC and the financial media.

Look, on September 16, Morgan Stanley was trading around $26. On September 17, it hit a low of $11. The stock was slashed in half in less than a day. That tends to happen when a company is under a full-scale attack by naked short sellers.

On the day after Morgan Stanley was slashed in half, the SEC banned short selling. It is fair to say that if the SEC had not acted, Morgan Stanley would not be with us today.

After the SEC banned short selling, hedge funds stopped circulating false rumors about the companies they had been attacking. Today, in anticipation of the short selling ban coming to an end, hedge funds began circulating false rumors about Morgan Stanley – the most damaging being that Mitsubishi had pulled out of an agreement to inject $9 billion of capital into the bank.

What happens tomorrow when those rumor-mongering hedge funds resume naked short selling?

As one prominent economist said, forebodingly, “We will see.”

  1. it is very suspect that the SEC abolished the uptick rule while they were in full knowledge that the subprime mortgage problem was unraveling. It would not take a rocket scientist to deduce that the SEC would have been able to anticipate the more rap[id obliteration of stocks that were troubled by these bad loans, with the loss of the up tick rule. The method has been consistent throughout – as Patrick said today on Bulls and Bears – pick out the weakest animal in the flock and then use an unregulated system to destroy the company….We will not have log to wait to see this play out further.

    It is absolutely mind boggling that this is taking place in full view and no one is doing anything to stop it….I feel like I am living a 24 hour nightmare….these are incredibly dark hours for our country

  2. I really don’t see the point of a short ban. During the ban, people traded knowing that the ban would soon expire and that short interest in the 900 could reach epic proportions when the naked shorting resumes. Would you buy a stock knowing that it would be shorted heavily within a very sort window?

    The only way the ban could do anything is if was long enough to bring the companies through a reporting period.

  3. You don’t need a short ban if the rules are enforced regarding locate borrow deliver and settle. Absent those rules being followed, shorting should be banned entirely, because the playing field is completely tilted toward the destruction of value.

  4. Sean,
    Sit down before reading this one.

    Lets add criminality to insult to injury……The Feds are a joke.

    AIG, Castigated for Resort Event, Plans Another One Next Week

    By Erik Holm and Hugh Son

    Oct. 8 (Bloomberg) — American International Group Inc., castigated by lawmakers for hosting a $440,000 conference days after an $85 billion federal bailout, plans to hold another gathering for brokers next week.

    The event, at the Ritz-Carlton in California’s Half Moon Bay, aims to “motivate and educate” about 150 independent agents who sell AIG coverage to high-end clients, said spokesman Nicholas Ashooh. “These sorts of sales meetings are an essential function,” he said. “We have them around the world all the time.”

    The White House, Congress and Barack Obama have lashed out at AIG for “wining and dining” executives at a weeklong conference last month at the St. Regis Resort in Monarch Beach, California. White House spokeswoman Dana Perino today called “despicable” expenses that included $23,000 for spa services, according to Representative Henry Waxman chairman of the Oversight and Government Reform Committee.

    President George W. Bush didn’t push for the bailout “to help top executives go to a spa,” Perino said today at the daily White House briefing.

    AIG Chief Executive Officer Edward Liddy, who replaced former CEO Robert Willumstad as a condition of the federal loan, today told Treasury Secretary Henry Paulson that the company intends to reevaluate expenses.

    `$400,000 Junket’

    “We understand that our company is now facing very different challenges,” Liddy wrote in a letter to Paulson. “We owe our employees and the American public new standards and approaches.”

    Obama, the Democratic presidential nominee, said during last night’s debate with Republican candidate John McCain that AIG should repay the U.S. Treasury for the costs of the event.

    “AIG, a company that got a bailout, just a week after they got help, went on a $400,000 junket,” Obama said. “And I tell you what: the Treasury should demand that money back and those executives should be fired.”

    In his letter to Paulson, Liddy said the gathering was planned “many months” before the Federal Reserve’s loan to AIG. Next week’s meeting was also planned before the loan, spokesman Ashooh said.

    “This sort of gathering has been standard practice in our industry for many years,” Liddy wrote. “Let me assure you that we are reevaluating the costs of all aspects of our operations in light of the new circumstances in which we are all operating.”

    About 50 AIG employees will also attend the Half Moon Bay meeting. Ashooh said he didn’t know the cost of the event or how long it would last. This meeting has more of an educational component than the St. Regis meeting, he said.

    Receipts provided by Waxman for the earlier conference at the St. Regis were dated Sept. 22 through Sept. 30. AIG agreed to the $85 billion loan from the government on Sept. 16, ceding a 79.9 percent ownership interest to the U.S. government.

    To contact the reporter on this story: Erik Holm in New York at [email protected].
    Last Updated: October 8, 2008 14:26 EDT

  5. The severe drop in the market may be from banks selling securities to get enough cash to buy back the fraudulent bonds they sold. BAC and others have come to a settlement with the SEC that they have to buy bonds that they knew were going to be illiquid and possibly worthless once they withdrew their auction bidding for same.

  6. If in fact the market goes into a free fall the DOJ should take over the SEC and detain Cox on the spot. There is no viable reason not to have the uptick rule. Every credible trader on Wall St. has said the same. Cox should be taken off the job immediately. There is no reason for Americans to be put thru anymore risk until everything stabilizes.

  7. What is it going for us to finally to realize that all of this is being intentionally done. What we need to try to figure out is WHY?

  8. Just a couple of thoughts. Mark, I apologize that they are not directly tied to your fine article.

    The constant effort by the opposition to blur the distinction between short selling and NAKED short selling reminds me of a similar tactic in another arena. Advocates of open borders / uncontrolled immigration / reacquisition of American land by foreign interests endlessly strive to blur the distinction between immigration and ILLEGAL immigration. In both cases the obfuscation is deliberate and premeditated, intended to both confuse the issue to casual observers and to bomb the opposition with an illegitimate ad hominem attack.

    Many anti-NSS advocates are quick to defend legal short selling as legitimate and necessary. I’m not so sure about his. The argument is made that shorting makes for an efficient market and avoids dreaded volatility. To me this sounds like SEC-style spoon fed B.S. If all shorting were ended, wouldn’t a stock’s price be determined by the sum total of investors’ opinions about the company’s prospects? What’s wrong with that? Seems to me that shorting in general throws a wet blanket of negativity over enterprise that is ultimately harmful. My hunch (naive though it may be) is that if all shorting were eliminated the market would function just fine for honest participants, though the crooks would be cut off at the knees.

    Does anyone know how long short selling has been a part of the market? Does it go back hundreds of years or is it a relatively recent practice?

    Having said all that, I guess I should affirm that I believe legal immigration to be essential and beneficial.

  9. Short selling has the same fatal flaw that all things human suffer.Fallen nature.

    Human greed and willingness to do wrong for self advantage. That is why we humans need to have laws. Trouble is that we have fallen back to trusting us humans who have a nature that goes to the dark side every time we attempt anything.

    Any question on why we need to trust God and not men? Without a system based on Divine moral directions with just treatment for all, not just those who have the club of power and money, we are doomed!

  10. Over the past decade from the repeal of Glass Steagall to the dismissal of the going short on the uptick rule we have a system that has placated the market participants to the detriment of the general public. We are now passing legislation based on the activity of daytraders (up 200 points or down 700 points). My point is who cares. The legislation should have been aimed at modifying loans (pricipal and interest rates) and get people back in their homes, the cornerstone of our country. Another ridiculous benefit to market participants is the ability for traders to short a company down to zero and never cover. (If I am wrong on this point please feel free to correct me) They never realize the gain and pay no taxes on the income. So the government has basically given the criminals incentive to destroy company’s and by the way you don’t have to pay any taxes on that money. Who is writing this legislation. If you look to the history of the SEC the first Chairman was notorious shorter Joe Kennedy (father of JFK). It seems that the deck has been stacked since 1933. After Franklin Roosevelt called Joe to Washington to clean up the Securities and Exchange Commission, somebody asked F.D.R. why he had tapped such a crook. “Takes one to catch one,” replied Roosevelt. taken from Wikipedia. Who is going to clean up the real mess?

  11. “We are not watching an economic rescue, friends. We are watching an economic coup. Creating and dumping trillions of dollars into the money supply is an act of war. But it’s a war with a specific purpose.”

    I met a regulator in Canada last week and he said not only is naked shorting legal in Canada, but it is encouraged to keep companies from becoming “overvalued” when companies keep the float too tight (which he considered to be manipulating the supply). Americans can open corporate brokerage accounts in Canada to skirt any new SEC short rules.

  12. Feedchipper, one problem is that the market has a herd mentality with everyone either buying or selling at the same time.

    The market would work (and has worked when it was banned in the thirties) without shorting, but you would get periods where no one can buy or sell a share because no one is on the other side of the trade. If the bid and ask spread gets too large, the market grinds to “by appointment only” trading. Shorting can lubricate the system if done with rules.

    If done properly, only margin account holders allow their shares to be lent in exchange for the right to buy shares without putting up all the cash. There is a maximum number of shares that can be lent as each share can only be lent once.

    A short would sell when demand is high (presumably overshooting an equilibrium stock price) and would buy when supply is high (undershooting an equilibrium stock price).

    It makes the market more liquid, but should be net neutral to the supply demand curve over time as the short would be expected to cover when there is a profit and would be bought in when the market continues to rise and he bet wrong.

    What makes absolutely no sense is to flood the system with IOU’s. No shares lent – just worthless promises. What makes even less sense is to sell people IOU’s for debt. Someone thinks they are buying a triple A government bond, but all they are buying is an IOU of a bond from a sleezeball brokerage.

  13. And, of course, who does CNBC have on air this morning, claiming that the ban on short-selling didn’t have any effect?

    None other than James Chanos…

  14. Tom Said: “I met a regulator in Canada last week and he said not only is naked shorting legal in Canada, but it is encouraged to keep companies from becoming ‘overvalued’ when companies keep the float too tight”

    So, this regulator says that it is wrong for a company to issue a fixed number of shares, and for people who own the company to hold on to their shares.

    I am of the minority opinion that the only reason stocks have any value at all is because their is a fixed number of stocks floating around.

    BTW, allowing shorts doesn’t really remove the ability of companies to manipulate the price of their stock by manipulating the float. It just creates a market where there’s more sneaky ways for hedgefunds and corporations to manipulate their float.

  15. Your statement “Look, on September 16, Morgan Stanley was trading around $26. On September 17, it hit a low of $11. The stock was slashed in half in less than a day. That tends to happen when a company is under a full-scale attack by naked short sellers.” All I can say about Morgan Stanley is too bad. They deserved this. Note: Morgan Stanley has been aidiing in the creation of counterfeit shares and has been making big bucks on this practice. Now its their turn.

  16. If there was only one bank and it was run by the government, there would be no requirement for any reserves as the only money that would exist would be chits in the bank’s computer servers. There would be no limit on the amount of money that could be issued, except that the total amount of money outstanding would dictate its value. If the amount of chits in the system was increased ten times, then each chit would be worth 1/10th as much, but there would be no concept of running out of money. The government could always issue more chits.

    If the number of chits outstanding were tied to the amount of goods and services (which is loosely tied to population), then the value of the money / chits would stay stable over long periods of time and there would be no boom or bust cycles and no need for the economy to always be growing. There would be an implicit concept of sustainability.

    The government could issue interest free loans based on ability to repay and the only fees would be for insurance on the loan failure and paperwork. The government could either give itself interest free loans or just issue money / chits directly. It would make no sense for a government to run out of money as they would have an infinite ability to produce chits / money. If they issued so many that it devalued the chits / money (inflation), then that would effectively be an extremely fair form of taxation. If they issued chits / money and it caused the amount of goods and services in the economy to increase (let’s say they spent it on infrastructure and employed lots of people), then they would get a free ride. The increased number of chits / money would correspond to an increased size of the economy and there would be no inflation.

    The system would have:

    – no taxes at all
    – no boom / bust cycles
    – no need for an economy to grow, with sustainability being implicit

    Why doesn’t it work this way?

    Well, it kind of does except the banking system is the one that prints money out of thin air and they lend it to the government at interest. The government taxes you to service that debt. Only the principle is issued, which means the economy is always short the interest and has to find it through inflation of the money supply next year. The system is mathematically doomed to failure every eighty years as the compounding interest goes exponential. Bankruptcy is a must, because like a game of musical chairs, there literally isn’t enough money outstanding to pay back all the loans. If all loans were paid off, there would be no money in existence and the interest would still be outstanding.

  17. The regulator was concerned with penny stocks with no business. The promoter could secretly own 99.9% of the float, so the stock that is out there could go extremely high during the pump before the dump.

    He said the naked shorts increase the supply to a more fair price of pennies for the worthless company.

    I asked him who decides what a fair price is and who decides what is worthless and why, if there is a buyer willing to pay the price, that that isn’t the fair price.

    And why does the naked short get a free profit at the expense of the investors writing the checks?

    He acknowledged that the pendulum may have gone too far in favor of the shorts.

    It smacks of communist style central planning and a total disregard for the invisible hand of the free market.

  18. Instead of giving the our banks new capital we should just nationalize them and invite the Chinese into open retail banking outlets here. This is favarable to our government printing money since the Chinese have all the real money anyway. To do anything else would be inflationary.
    The only regulatory caveat would be that the chinese banks would have to list on our stock exchanges. Our Hedge Funds would then run the stock up to fairly high levels only to build a short position in them. Then they would dillute the shares by naked shorting them into the ground.
    It’s what we did to the Japanese in the 80’s when they were flush with our cash and bought our real estate. It’s what we did to the Indians too.
    Thank God for our form of honest and fair free marketcapitalism. It’s the “Gold Standard”

    Long Live Christopher Cox, George Bush,Chris Dodd, and Richard Shelby from the Government, Joe, Nocera, Herb Greenburg, Jim Cramer, Ben Stein, Larry Kudlow, Aurturo Bris, John Markman, Gary Weiss, Fat Lips Carol Remond, Maria Bartiromo and the rest of the the talking shills at CNBC defending and worshipping their paymasters like Jim Chanos, Stevie Cohen, Bill Ackman, David Einhorn, David Rocker, Mark Cahodes and hundreds of other hedge fund managers. And a special shoutout to their scout Richard Baker.

    Unfortunately the hardworking inhabitants here are the new Indians and the Hedge Funds have given us all a new form of smallpox.

    Stop naked shorting now !

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