Comments on: McCain Gets Something Right (Sort Of)

By: conradg

conradg — Fri, 19 Sep 2008 20:20:28 +0000

I agree that a temporary ban on short selling during sudden market declines is often a good idea, as long as we don’t confuse such measures with curing the problem itself, which has nothing to do with short-selling. In reality, short-selling, if allowed years ago, would have helped prevent the bubble in the first place, by putting a check on unwarranted upward speculation. The problem has been an imbalance in speculation, with huge margins in stocks and derivative in place that encourage prices to soar unnaturally, and little downward pressure from smart short sellers to counterbalance this. THe result is often an unrealistic rise in prices, creating a bubble, that finally gets released in a crash as all of a sudden everyone begins to realize that the prices were imaginary and prices fall suddenly. If that information was brought to the fore much sooner, before prices soared unrealistically, the bubble and consequent crash could have been avoided, and prices could have maintained an orderly and senseible reflection of real value, which is much heathier for the market and the economy. In other words, McCain has no idea what the fundamentals of the economy really are, and how out of whack they have become. The real enemy here is unconscionably high leveraged margins on both loans and derivatives, leading to the manufacturing of fake capital in loan, stock, and commodity prices. When everyone suddenly realizes that large amounts of the nation’s capital are actually phantoms, the resulting crash can be devastating.

By: Daniel Larison

Daniel Larison — Fri, 19 Sep 2008 05:56:36 +0000

Thanks for that. That is what I aspire to make Eunomia, so I’m pleased that you find it worthwhile. Of course, the credit for the level of discussion also goes to my regular readers and commenters.

Okay, it’s probably true that McCain latched onto the issue because it made him sound as if she sort of knew something, when he didn’t. I still don’t buy the anti-uptick argument that the rule was simply obsolete and useless, but I’m willing to grant that McCain couldn’t really explain why that rule mattered one way or the other. McCain would have been better served to criticize the loosening of rules on debt-to-capital ratios, and he would have definitely been well-advised to criticize the extensive use of mortgage-backed derivatives, but that would have also required more of a grasp of the situation than he possesses.

I would still maintain that we have seen short-selling not so much provide additional information this week as contribute to a panic, especially this week. I understand that short-selling can provide information and liquidity to a market, and so it is a useful mechanism, but it can be abused and in the last few days I think it’s fair to say that it has been.

From Bloomberg on the possible SEC temporary ban on short-selling:

“Morgan Stanley and Goldman Sachs Group Inc., the biggest U.S. securities firm, are seeking to avoid the sort of run on their shares that helped trigger emergency sales of Merrill Lynch & Co. and Bear Stearns Cos., and the Sept. 15 bankruptcy by Lehman Brothers Holdings Inc., once the fourth-biggest.”

The causes of the weakness of these firms are to be found elsewhere, I agree entirely, but if you don’t want still more brokers going under and exacerbating the situation it seems to me that reining in short-selling is one way to help stop that.

By: LibAl

LibAl — Fri, 19 Sep 2008 04:09:06 +0000

Hmmmm… its hard to understand how a financial instrument (out of many) employed during this crisis can be considered faulty. After all shorting serves many healthy purposes in a normal market that seeks efficiency. Would we consider buying stocks long in a frothy market to also fall under such distinction? The truth is that shorting exacerbated the loss of confidence in a company (such as Lehman) but can hardly be considered a cause nor merit presidential(-candidate)-level umbrage in managing such a financial crisis. Lehman failed because it could not raise short-term capital due to the market’s loss of confidence in its ability to service such debt. With its books under considerable strain the company needed such short-term debt to operate and consequently folded as that disappeared. McCain deserves no credit for mentioning shorting – I think he merely employed it as a technicality to appear knowledgeable and tuned to the crisis.
Awesome insight can be found here: http://freakonomics.blogs.nytimes.com/2008/09/18/diamond-and-kashyap-on-the-recent-financial-upheavals/

Daniel – I am a newcomer to your blog but absolutely love your insights, ken and, speed and clarity of thought. And the community you are fostering here takes debates to exceptional levels. No BS and very informed. I may not agree with all views but appreciate the manner in which they are expressed. Thank you all!

By: conradg

conradg — Fri, 19 Sep 2008 01:57:08 +0000

I don’t see how short-selling did anything but good for the general public, in that it warned people that something was direly wrong with Lehman. Companies don’t go under because their stocks fall in value. That has nothing, absolutely nothing, to do with going bankrupt. They went backrupt because they made incredibly bad investments that lost tons of money. Short selling may have ruined their reputation sooner than otherwise, but it saved unwary investors from shovelling any more money down that sinkhole. The rules that could have prevented this had nothing to do with short-selling, and everything to do with limitations that used to be in place for making crappy loans in the first place. These rules were scrapped, not by the SEC, but by Republicans in congress who wanted a less regulated mortgage industry, because we all know that free markets never go wrong. The SEC has no oversight of the mortgage industry whatsoever.

By: Adam01

Adam01 — Thu, 18 Sep 2008 21:18:29 +0000

” McCain happens to have wandered into a sensible position, but it is still sensible.”

Ok, so he’s got the reinstatement of the rules governing the timing of a short sale, opposition to ethanol…

Yeah, that’s about it.

By: Daniel Larison

Daniel Larison — Thu, 18 Sep 2008 21:00:25 +0000

Lehman’s problems were not the fault of short-sellers, as we all know, but the loosened rules on short-selling were responsible for driving the stock down so far so quickly. The loosened rules are undesirable in and of themselves, and the failure to enforce existing rules is a definite failure on the part of the SEC. I’m not suggesting that McCain has a clue what’s going on. McCain happens to have wandered into a sensible position, but it is still sensible.

By: conradg

conradg — Thu, 18 Sep 2008 20:54:15 +0000

This is wrong all the way. Short-selling certainly is a pain in the ass, but the reason the market is in trouble has nothing to do with short-selling. Short selling only works when the company in question has fundamental problems that the market isn’t taking into account. If the short-sellers are wrong about the company, they lose their ass. They only win by being the first to realize when a company has gone into the tank, and they force the issue to the fore. In that sense, they do the market good, by bringing bad companies to light faster than they otherwise might.

Lehman’s problems were not derived from short-sellers. They were derived from incredibly risky and stupid decisions by the people who ran Lehman. Replacing Cox is just making a high profile scapegoat for the idiots who actually ran Lehman and other investment firms into the ground. McCain as usual has zero grasp of what is at the core of this whole scandal, which is was a policy of loose credit and virtually zero risk assessment by firms who were confident the government would bail them out regardless of how stupid they were. Look at it this way, if you have the choice of a normal bet with normal returns and risks, and a highly risky bet with a very high profit potential but almost no corresponding loss potential because the government would bail you out if you screwed up, which bet would you make?