Downtick, uptick, downtick
The Market had quite a downtick yesterday. CNBC’s Jim Cramer attributes at least a small part of the mess to the lack ot the uptick rule:
To me, this was all pretty obvious. I was a short-seller, and I know that when a stock gets hit, people fret about the company regardless of whether the company is in good shape or not. There was a time that AIG had an immense amount of capital and it bought its stock back hand over fist in the $60s, and so it was somewhat able to defend itself from short-sellers. Even then, though, there were strict limits to when and how much companies could buy of their stocks. There are no such limits as to when short-sellers can operate.
So, without an ability to slow the short-sellers down by forcing them to wait for buyers to come in and pay up, and with no ability to demand that short-sellers or their brokers borrow stock first to short directly or to sell puts to the customers, shorts were able to take AIG down from the $20s to $4 in a week’s time.
To be sure, there were plenty of problems with AIG…What matters, though, is how easily hedge funds were able to take this company down through endless selling. The academics at the SEC had no idea how important their rules were when they put in the bottom on July 15, and they had no idea how catastrophic it would be when they pulled them…
I don’t know a soul in the business, save short-sellers, who have participated in these raids who doesn’t agree with this dynamic. Yet Cox has steadfastly refused to go back and reinstitute the rules and bring the playing field back to where it was before I retired in 2000 — to a time when I remember how difficult it would be to create these forest fires given the breaks. The speed is and was too great to put out the fires, so Lehman went and then AIG looks like it is going.
When we last visited the issue of the uptick rule in July and called for re-instituting it, we thought that it had been reinstated only a few days later, but it turns out that that was only in very special and limited circumstances. It turns out that the SEC was actually thinking of getting around to doing something in late September, as the WSJ reported today:
Securities and Exchange Commission Chairman Christopher Cox assured Wall Street chiefs amid a series of weekend meetings over the fate of Lehman Brothers Holdings Inc. that the SEC would institute protections soon, this person said. The SEC is expected to move up the timeline for finalizing two rules to as soon as this week, from late September.
The rules, which require the approval of the five-member SEC, would stiffen requirements on options market makers involved in short sales and make it illegal for a trader to mislead his broker about locating stock to short and then failing to deliver it within three business days, this person said. Wall Street firms earlier this summer successfully lobbied the SEC to restrict certain types of short sales for 19 financial companies.
The idea behind the new rules is to rein in traders who borrow stock to short and then are late or never return it. Market participants say that can have a cascading effect on a company’s stock…
Great sense of timing, fellas. (By the way, we happen to agree with the notion that the bankruptcy of AIG would be “as close to an extinction-level event” as we have seen since the Great Depression.)
September 17th, 2008 at 8:28 pm
I keep saying the following, and I hope that repeating it is not fiddling with first principles while the financial system burns. The markets should treat buyers and sellers evenhandedly. To that end, the SEC prefaced its repeal of the uptick rule with a crackdown on naked shorting, and the agency continues to implement that crackdown. I don’t favor reimposition of the uptick rule, but if the rule is brought back it should be balanced by a downtick rule on margin purchases.
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Jim Cramer readily went long-short when he ran a hedge fund but his current customer base is retail investors who primarily go long (and his stock is down over 60%). This Jim Cramer:
Cramer is an energetic entrepreneur, but that doesn’t mean he’s cut out to formulate long-term policy.
September 18th, 2008 at 12:08 am
Aren’t the current rules for company buy backs that they must buy on a downtick? If I am correct in that, then should they not be freed as the shorts are to buy or sell in the open market?
September 18th, 2008 at 5:24 am
Doug, you’re essentially correct: violating a downtick condition exposes a company to liability for stock manipulation.
At first blush I agree with you. If buyers and (short) sellers are exempt from uptick/downtick conditions, then buybacks should also be exempt.
To some extent it’s a special case when an entity deals in its own shares. IMO it’s sensible to forbid a company or its insiders to short the stock (as was done during the 1929 period). Maybe similar considerations hold for the buyback downtick condition, but offhand I don’t see why they’re compelling enough to put buybacks at a disadvantage to other purchases.
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Hey, if we’re going to regulate, let’s regulate effectively.
A modest proposal:
This way stocks will only go up!
September 18th, 2008 at 10:11 am
One of the country’s most famous traders, who spurned incredible wealth to heed a call to public service, has also advocated–in a laudably measured manner, whether one agrees or not–reexamination of the uptick rule.
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Seriously:
Assume for the sake of argument that the market is locked into a downward spiral and a catastrophic crash can only be avoided by external intervention.
Ad hoc, kneejerk regulatory responses are even more transparent attempts at manipulation than what short sellers are allegedly doing. At worst, such responses, coming on the heels of political/bureaucratic incompetence and phony reassurances from Fannie, Freddie, Lehman, et al, will only aggravate the panic. At best, kneejerk regulation is likely to lock in distortions that will impair the competitiveness of US markets going forward.
If the threat is not catastrophic, let the market do its work of creative destruction[1]. If the threat is catastrophic, close the market for a week or two and coordinate a solution with a critical mass of domestic and foreign heavy hitters.
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[1] There is also the alternative of letting the market sort out the mess even if the threat is catastrophic.
September 23rd, 2008 at 2:54 am
A red face and mea culpa for a previous comment.
If an investor acquired a stock sufficiently under the current price, of course the price can decline while he sells at a profit.
I don’t have this securities-regulation thing down pat yet, but if at first you don’t succeed…
The correct answer lies in the uptick rule. Don’t just reinstate it. Give it teeth!
Take that, you unAmerican pessimists!