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September 19, 2008

Comments

randy

This past week Paulson, Bernanke, and congress came to a crossroad where they faced two terrible choices. They chose the one that presumably postponed the immediate financial pain that clearly seemed inevitable for the masses. History will tell us how wise that decision was. However, the choice clearly places ANOTHER very expensive burden on taxpayers for decades to come and probably violated the constitution in the process. One small step for a few men…...one giant step for socialism.

don

Ditto to all the above and couple that with all the knee jerk government regulations/intervention and viola we become more like europe..i.e. "zero growth"...i dont necessarily like shorts but they do weed out the weak..Is'nt that how God set it up in the good ole animal kingdom?

Austin

Ron Paul had some interesting things to say about the last two days: http://www.campaignforliberty.com/blog/?p=554

On a related note, I thought I might comment on the restriction on short selling. That kind of measure seems like it would effect one of two evils. Either it would 1) create another bubble in the markets (i.e. value of stocks etc wouldn't be accurately reflected by prices) akin to the "irrational exuberance" of the housing market, or 2) create, in effect, a freeze on market activity--a climate in which companies not wanting to go long based upon bleak future expectations, but forbidden from changing their net position will resolutely do absolutely nothing.

How can such a measure possibly do anything other than compound the harm that our leaders say they're trying to avoid?

Jim Fleming

Let me add a comment about one of the provisions of the plan to which you allude, Austin. Because of concern about "naked" shorting of stocks in the financial sector and possible manipulative abuses, going short (whether naked or not) on 800 or so companies on a select list is a no-no. What does this mean?

First let's clarify what "going short" and "going long" tell us about what's in a man's head. All market participants (both longs and shorts) seek to do two things: "buy low and sell high." Being "long" or being "short" differ by the order in which these two acts occur. A long buys first and sells later. A short sells first and buys later. (The short is able to sell something he does not yet possess by borrowing shares from a third party whom he will repay when he "buys" and closes his trade.)

A long is an optimist, a short is a pessimist. The long expects to make a profit as the value of his shares go up. The short expects to make a profit as the value of his shares go down. The optimist can be wrong - if the value of his stock goes down, he realizes a loss when he later sells. But he buys stock on the expectation and in the hope that it will go up. The pessimist can be wrong, too, and will realize a loss if the stock he has sold goes up and he has to exit his position as a higher price. So pessimists and optimists can both lose and make money as they participate in the market - they just come to the market with a different view of what the future holds.

Here's where I find the "no shorting" rule to be a violation of free market principles. By prohibiting shorting, the SEC is barring pessimists from participation in the market. In effect they are saying, "As it pertains to the 800 or so slect companies whom we deem worthy of our benevolence, you may only participate in the market if you are optimistic about their future. If you are pessimist, please leave." Kind of like, "no service without shoes and shirt." This is "no buying and selling without smiley face."

All those smiley face investors are not guarantied to make money. Their high hopes could be misplaced and their stock could still go down. But, at least they will have the pleasure of knowing that all the pessimistic riff-raff has been run off and won't be making anything if they are losing.

The SEC is saying, "only optimists served here." Yep, that will restore confidence. We'll run off all the doom-and-gloomers.

Austin

My understanding was that short-selling was not banned, but that no company would be allowed to go net short. In other words, if a fund wanted to go short on something, it has to balance that short with a long elsewhere on its books. The only problem (again according to what I've been told, so I'm open to being better informed of the facts) is that some of these larger financial actors don't communicate particularly effectively inter-departmentally. Thus, since none of these companies' different departments can coordinate with one another to balance their shorts with their longs (to keep from going net short) they have just decided to freeze in position--to, as I said before, "resolutely do nothing." So, one question I have is: is this an accurate picture of what has been implemented? If not, please enlighten me.

Second, my question based upon these facts is still un-answered--how can this not either 1) create a bubble (because since only the optimists are left, there will be no pressure on prices to accurately reflect values, i.e. irrational exuberance) or 2) stop trading activity in its tracks (on the assumption that irrational exuberance does NOT take root, but people who otherwise would go short are prevented from making use of that option and thus must sit and twiddle their thumbs, hoping that their holdings diminish less than they already expect them to.)

I get that banning shorts is a philosophical betrayal of free markets. And, I definitely oppose such a measure. But, I am also interested in the future economic consequences that we can expect when a market no longer permits a short position. Do you agree that scenario one or two is a possible outcome which banning short sales would effect?

Jim Fleming

Here is a link to a more detailed account of the measures being taken: The SEC is banning all (not just net) short selling on the 799 "elect" for a period currently set to expire on Oct 2 - http://www.marketwatch.com/News/Story/sec-bans-short-selling-hundreds/story.aspx?guid=%7BFF3CA343%2D2485%2D4B0C%2DB971%2D7FBFA0AD4611%7D

As regards your two possibilities, I think these are not exclusive options nor the only options. There will be a dampening effect on the market - this is, in part, something the SEC wants to achieve to "calm things down." I think there will also be a mixed reaction to these and other measures. Some will think, "finally the government is getting serious; I guess the worst is over." Others (like me) will remain skeptical and see in these measures "solutions" that are only making the real problems worse. I don't think there is room for much of a bubble in the valuations of the "elect." There has been too much damage to investor sentiment and the time frame is too short for someting like this to take hold.

That being said, the market is being driven by emotions far more than facts right now, so it is difficult for anyone to predict which way the herd will stampede. The SEC is trying to calm the herd in hopes they won't bolt.

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