Peak Insanity

The Securities and Exchange Commission took its most aggressive assault against bearish stock bets by stating its intention to issue a temporary ban on short-selling.

SEC Chairman Christopher Cox briefed Congress late Thursday of the agency’s intention to take the extraordinary step of interfering with the market’s regular functioning. Short-selling is a trading strategy of selling borrowed stock in hopes it falls and can be repurchased at a lower price.

It’s unclear if the SEC’s intention has been approved by the commissioners, which is required, and whether which stocks are covered or for how long it will be in effect. Earlier this summer, the SEC moved to restrict certain short-selling practices for 29 days, covering 19 financial stocks.

Thursday, the U.K.’s Financial Services Authority said it would ban short selling in financial stocks until January. The FSA said it would review the effect of the ban each month. The FSA also announced additional disclosure requirements from hedge funds of short-sales if a certain threshold is met.

The SEC’s decision comes amid increasing concern that short-sellers are abusing legal trading strategies to drive financial stocks lower. Since the near-collapse of Bear Stearns & Cos. in March, regulators have been looking into a combination of short-sales and false rumors are part of the problem.

U.K. Treasury Chief Alistair Darling, who was involved in the FSA’s decision, said in a statement Thursday, he welcomed the FSA’s "decisive action." He said in current market conditions it was in the "interests of financial stability."

The pressure to step up efforts against short-selling gathered steam since last weekend when Lehman Brothers Holdings Inc. steered toward bankruptcy and Merrill Lynch & Co looked for a buyer. Wall Street executives urged Mr. Cox to take steps to slow the sell-off, which they believe is triggered by heavy short selling.

Investment banks are particularly vulnerable to low stock prices as it hurts their ability to raise capital to secure their funding.

The SEC sped up its rule-making and on Wednesday the SEC announced three trading rules that were aimed at curbing abusive short selling. That was followed late Wednesday night with intentions to require hedge funds to disclose more information about their short positions.

Wrecking of United States of America

My friend "CS" emailed me this evening.

I am almost shaking as I write this for what is happening to the capital markets, this country, and the free world. The impact of the past two weeks’ action in the financial markets, if not reversed by cooler heads, will have irreparably changed the world in a way that only terrorist attacks and acts of war have in the past.

Nationalizing Fannie Mae and Freddie Mac, providing an emergency quasi-legal bridge loan to AIG, temporarily banning short-selling on all stocks in the US, and instituting an RTC-type entity to handle the toxic waste of the financial system is economic violence on a grand scale.

The long-term cost of these actions to dollar holders will likely be in excess of $1 trillion. The basic premise of a free economy is one governed by laws and not men, where property rights are respected, where individuals are free to make contracts with each other, and where honesty and transparency exist in the marketplace. It’s questionable whether any of these currently exist in the economy of the United States.

Before I continue let me provide a partial list of entities responsible for the financial mess we find ourselves in:

• -Fractional-reserve banking, which is inherently unstable and entirely a confidence game
• -Congress for passing the Federal Reserve Act and creating the Federal Reserve, the third central bank in the history of the US
• -Woodrow Wilson for using the Fed to finance World War 1
• -Benjamin Strong, the President of the Federal Reserve Bank of New York from 1914-1928, for inflating the money supply in the ’20s to help out Great Britain which led to the Great Depression
• -Herbert Hoover for his economic intervention from 1929-1932. He was not laissez-faire by any means.
• -John Maynard Keynes for laying the foundation of a miseducated public
• -FDR for banning private ownership of gold, enacting the New Deal, creating Social Security and Fannie Mae, and exacerbating the Great Depression
• -The FDIC for lulling the American public into a false sense of security regarding their bank deposits and training the public to unquestionably trust the financial system
• -LBJ for the guns and butter of the ’60s
• -Nixon for severing all ties between the US dollar and gold
• -Reagan’s intellectual duplicity, using free market, small government rhetoric while turning the US into a chronic debtor nation
• -Alan Greenspan, one of the most duplicitous, arrogant, and incompetent individuals in the history of the United States. If I had to pin this crisis on any one man, it would be he.
• -George W. Bush for cutting taxes while raising spending and his full embrace of Cheney’s doctrine of "deficits don’t matter"
• -Ben Bernanke for following the Greenspan doctrine to its inevitable conclusion
• -The heads of Fannie Mae and Freddie Mac for using artificially low borrowing costs to create systemically-dangerous housing institutions
• -Christopher Dodd and Barney Frank for beating the socialist drum
• -Christopher Cox for thinking a ban on short-selling will solve anything
• -Hank Paulson for folding the hand he was dealt
• -The ratings agencies for rubber stamping garbage assets as AAA
• -The heads of the major banks and brokerages on Wall Street for turning a blind eye as their institutions were taking on massive leverage that threatens to take down the financial system
• -The hedge funds that levered up structured finance to dangerous levels
• -Generations of lawmakers for kicking the looming financial crisis can down the road
• -Home buyers who lied about their income and creditworthiness
• -Predatory lenders who put people into mortgages they could never afford

Frankly, I don’t know where we go from here. Despite what government officials want, you cannot intervene your way to renewed credit and economic growth. The excesses of the past 25 years have come home to roost, and if we aren’t careful this country’s status as the hub of global capital markets and the holder of the world’s reserve currency will disappear.

Freezing foreclosures, mandating artificially low mortgage rates, sweeping junk assets on bank balance sheets under a Level 3 rug, delaying the writedown of debt, pursuing a witch hunt against legitimate players in the capital markets, and having the government be the lender and borrower of last resort will do nothing other than recreate the mistakes of the 1930s. Short-selling isn’t taking down financial firms, overlevered balance sheets of bad assets is.

This country has a lot of problems.

We have made commitments, militarily and to future retirees, that we cannot keep. We have an aging infrastructure and a reliance on diminishing fossil fuels. And we have lost confidence in the principles that led to our rise as the beacon of the free world. But there is a lot to embrace as well. We have great traditions of freedom and entrepreneurship. We have an educated, skilled populace that wants to make a better world for our children. And we have an undying belief in the American Dream, that hard work and thrift make the rags to riches story a possibility. But if we are to thrive in the 21st century we must reject the failed ways of the recent and not so recent past and rediscover that which made those who came before us proud to be American.

Thanks for reading,

CS

Slope Of Bailouts Is Slippery And Expensive

On September 11 in Slope Of Bailouts Is Slippery And Expensive I stated:

A quick check of my calendar shows next week is options expirations week. What stunt might Bernanke and the SEC pull now? Eliminate naked shorting across the board through the end of the year? Conduct a séance? Howl at the moon?

I vote for the séance. There are many dead banks with whom Bernanke can communicate.

Apologies offered for the séance prediction. At least I considered the options. Most did not. With that in mind, I cannot predict (nor can anyone else) when this manipulated rally will fizzle out, one can only state that it will.

Mike "Mish" Shedlock