Zachary Goldfarb, a Washington Post staff writer, discusses (p. A10, “SEC Moves to Limit Short Sales of Stocks”) this SEC proposal – sympathetically. The article is naïve – buying the complaint of “High-profile Wall Street executives” that short sellers “played an outsized role in crashing the stock values of several major financial services companies.” Now, it is certainly true that when an asset value is falling, some will anticipate further declines and sell short – just as many will anticipate that an asset whose values are rising will rise further and buy long.
But in politics, as elsewhere, while success has a thousand fathers, losses are orphans. Thus, many clamor for curbs on short selling, but there are few calling for curbs on those betting on things still going up. That is we critique irrational exurberance but we penalize only rational prudence. The story betrays this bias wonderfully in a telling quote: “The SEC [proposed rules are]… making it more difficult for speculators to pounce on a stock when it is already declining sharply.” (italitics mine).
Imagine SEC rules designed to make it more difficult for speculators to pounce on a stock when it is already increasing sharply!
When markets boom, politicans take credit. When markets tank, politicians blame the speculators. Unfortunately, this bias means that Congress may further cripple the market’s ability to stabilize, to ensure that all information positive as well as negative reaches the market price. Suppressing information is a bad deal – in civil societies and in the market.
In the House Financial Services Committee hearing Monday on Bernard Madoff’s $50 billion alleged Ponzi scheme, some good points were raised by Congress members of both parties. One was particularly relevant:
Representative Stephen F. Lynch, Democrat of Massachusetts, said short-sellers seemed to know about the Madoff fraud and the S.E.C. should have seen it coming. “The short-sellers knew it was coming and they invested in it — how did they know and the S.E.C didn’t,” Mr. Lynch asserted. “These short-sellers were able to diagnose it, bet on it and make a killing on it.”
Lynch’s point was a little unclear. Madoff’s company was not publicly traded, and thus couldn’t be shorted in the traditional sense. Lynch could have been referring to two related issues though. One is that hedge fund managers such as Harry Markopolos were apparently coming to the SEC to blow the whistle on Madoff. But their appeals fell on deaf ears
The other point is, as John Berlau has noted before on OpenMarket, that short-sellers knew the subprime crisis in general was coming and profited from that fact. Had short-selling rules been liberalized for vehicles such as mutual funds as well as hedge funds, many more retail investors could have profited as well, and the bubble may not have grown nearly as big if more shorts had balanced out the bullish longs.
Lynch should be applauded for standing up for the beleaguered shorts. And his words of praise for them hold out hope that Congress may, at last, come to realize that contrarians – those who view rapidly (apparently) appreciating assets as dangerous and invest so as to dampen such “irrational exuberances” — play a valuable and suppressed role in the market. Perhaps, that thinking may lead to reforms of laws discriminating against short sellers.
Since the $700 billion bailout was first proposed, whatever the stock markets did, much of the press took that as a sign that the market wanted more government intervention. The markets sinking on Sept. 29, the day the House voted down the first bailout bill (although much of the sinking was before the bailout was defeated), was a sign that markets needed the bailout. Then, when it went up about 500 points the next day, it was somehow explained as anticipation of Congress passing a new bailout.
The press was somewhat at a loss for words when the market tanked all last week, just after the bailout had been passed. But yesterday, when the Dow Jones Industrial Average zoomed up 900 points, the explanation was that the markets just loved the forthcoming global bailouts and partial nationalizations. Comedy Central’s Stephen Colbert, as he so often does, cleverly mocked this conventional wisdom. On last night’s Colbert Report, he reported on “Henry Paulson’s plan to change his plan to whatever the Europeans are planning is working.”
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