no empirical evidence to support the belief that short-sellers are to blame for much of anything

From Floyd Norris:

"Nail the Shorts?

The S.E.C. is putting out for comment a bunch of possible short-selling restrictions today. There are several variations on two ideas. First is an uptick rule, like one we used to have, that bars short-selling at a price lower than the last different price. Second is some type of circuit breaker, such as barring further short sales of a particular stock on a day that stock has fallen 10 percent.

I assume the commission will eventually adopt something. The pressure from Congress, and the public, is great.

And I suspect that the eventual impact of what they adopt will be modest, at best.

Listening to the five commissioners speak was refreshing, in contrast to the unlamented S.E.C. during the chairmanship of Christopher Cox. Last fall, the S.E.C. introduced panic measure after panic measure to halt or reduce short-selling. There was little effort to carefully consider whether there was any evidence to support the measures, which seemed to change every hour or two. Then they had to be tweaked as unanticipated consequences piled up.

This time, all five commissioners, led by Chairwoman Mary Schapiro, seemed to understand that there is no empirical evidence to support the belief that short-sellers are to blame for much of anything, even if there is public outrage. Whatever rule is adopted will be chosen after everyone has a chance to comment and point out unintended consequences.

It sounds as if panic is receding at the commission."

Me:

“This time, all five commissioners, led by Chairwoman Mary Schapiro, seemed to understand that there is no empirical evidence to support the belief that short-sellers are to blame for much of anything, even if there is public outrage.”

I’m not for these rules, but I have to admit that we have some rules and regulations just to get citizens to buy into our system. Right now, I guess, we’re having a hard time getting people to buy in. Hence, rules without any proven purpose. Before, we had rules without any proven enforcement.

— Don the libertarian Democrat"

The proposed restrictions on these so-called short sales follow a lobbying campaign by financial institutions

TO BE NOTED: From the NY Times:

"Some Revile Plan to Limit Short-Selling

By STEPHEN LABATON

WASHINGTON — Responding to the depressed financial markets, regulators for the second time in less than a week are preparing to take steps that could have the effect of temporarily shoring up stock prices. But in the process, some critics say, the measures could undermine the integrity of the markets.

On Wednesday, the Securities and Exchange Commission plans to announce several proposals to permanently restrict traders from making bets that stock prices will decline when those prices are already dropping.

The proposed restrictions on these so-called short sales follow a lobbying campaign by financial institutions and other companies, which have experienced sharp declines in their stock prices, and their allies in Congress.

Short-selling is the practice of borrowing stock and selling it in the hope that its price declines. If it does drop, then the seller profits by buying it back at the lower price and returning the borrowed shares.

Some companies and Wall Street executives have blamed short-selling for needlessly accelerating declines in stock prices and contributing to the demise of companies like Bear Stearns and Lehman Brothers.

Other market players disagree. They say short-sellers are the market’s whistle-blowers, and their stock trades and skeptical analyses of corporate balance sheets are essential to the efficient functioning of the markets. Many large investors also use short-selling techniques as a hedge to protect them against losses in declining markets.

Officials were working through the weekend to draft several possible rule changes, including a tougher variation of a former rule that prohibited short sales while a stock price was declining. That rule, known as the uptick rule, was put in place in 1938 in response to the market turbulence of the Great Depression. It was repealed two years ago. The uptick rule was more restrictive for short-sellers trading stocks listed on the New York Stock Exchange than those trading on Nasdaq. But one of the new proposals could change that and make it more onerous for short-sellers on all exchanges.

The S.E.C. also plans to announce that it is considering a proposal by the major exchanges that would impose restrictions on short-selling only after a stock suffers a daily drop by a specified percentage.

Last year the commission imposed a series of temporary and hastily drafted restraints on short-sales after heavy pressure from Wall Street and the Treasury secretary at the time, Henry M. Paulson Jr.

The move this week follows the decision last Thursday by the Financial Accounting Standards Board to give banks greater discretion in putting a value on their sharply declining mortgage securities.

The standards board initially resisted making changes to the so-called mark-to-market rules, but quickly relented after its chairman, Robert H. Herz, came under withering attack by lawmakers.

The slumping financial markets have been rebounding steadily in the last month for many reasons, including the regulatory and legislative decisions in Washington. The Dow Jones industrial average closed on Friday above 8,000, a major gain from the 6,500 level of four weeks ago.

Examining short-selling practices has been a high priority for the S.E.C.’s new chairwoman, Mary L. Schapiro. She said in a recent interview that even before she arrived at the commission, she had heard from thousands of investors and others that the elimination of earlier restrictions had led to greater market volatility.

“This is a tough issue and that’s why we’re going to be very deliberative,“ she said last Friday. “You won’t see emergency orders or midnight proclamations. We want to go through the regular rule-making process and understand whether there is a nexus between removing” the earlier restrictions and undermining investor confidence.

There has also been growing political pressure for the commission to act.

A bipartisan group of six senators, led by Senator Edward E. Kaufman, Democrat of Delaware, has demanded tighter restrictions over short-sellers. Mr. Kaufman, who took the seat of Vice President Joseph R. Biden Jr., made short-selling restrictions the first piece of legislation he introduced.

But supporters of unfettered short-sale trading have said that the practice is a convenient scapegoat and that new restrictions are simply punishing traders who have legitimate reasons for believing that some companies have had overvalued stock prices.

They have also said that the changes in the accounting rules and the proposals to restrict short-sellers threaten to undermine the independence of the regulators and show their willingness to buckle under heavy political pressure.

“It’s unsettling that Washington continues to focus its efforts on issues that have nothing to do with causing the crisis such as short-selling or stricter and more transparent accounting measures,” said James Chanos, president and founder of Kynikos Associates, a hedge fund company that specializes in short-selling. “If anything, both practices should be encouraged.”

Officials said that one of the proposals to be announced on Wednesday would be based on the best bid price of a share of stock and the other on the last price. The different approaches reflect the differences between the Nasdaq trading rules, a dealer’s market where stocks are traded electronically at ranges set by hundreds of market makers, and the New York Stock Exchange, a modified auction market, where the price is set centrally.

The purpose of the old rule was to prevent short-sellers from accelerating a declining market. Under that rule, short-sellers had to execute their initial trade at or above the last trade, as long as that trade was higher than the previous transaction, for companies listed on the New York Exchange.

But for Nasdaq companies, short-sellers could sell at any price so long as the trade was executed after the “best bid” price of the share had been raised from the previous best bid. As a result, the uptick rule had a far more limited effect for short-sellers interested in trading the stock of Nasdaq-listed companies.

In recent days, the commission has received comments about the plans to curtail short-selling. In an about-face, the operator of the New York Stock Exchange, NYSE Euronext, joined by several other large and small exchange operators, asked the commission to reinstate a version of the old uptick rule. The exchange said it was necessary to curtail abusive short-selling that had harmed investors and listed companies.

But in proposing to repeal the old rules two years ago, the New York exchange wrote that “short-sale price restrictions have become not only unnecessary, but also their continued maintenance will serve only to interfere with the mechanisms of an efficient market.”

Larry Leibowitz, an executive vice president at the N.Y.S.E., said the exchange’s new view was the result of its experience over the last year.

“We have seen conditions that we never saw before,” Mr. Leibowitz said. But opponents of the restrictions said that the temporary rules from last year might have briefly halted some stock declines, but that they were counterproductive.

“When you have these sorts of restrictions you may have a little spark in the market,” said Eric W. Hess, general counsel of Direct Edge, which claims to be the third-largest stock market in the United States. “But that perception quickly evaporates.”

“These bans are all worthless,”

TO BE NOTED: From the FT:

"Ban on shorting banks failed miserably, say experts

By James Mackintosh in London, Tom Mitchell in Hong Kong and Elizabeth Fry in Sydney

Published: March 10 2009 22:48 | Last updated: March 10 2009 23:28

The US Securities and Exchange Commission will next month consider whether to propose reinstating a market rule designed to prevent “bear attacks” on stocks from speculative traders.

The so-called “uptick:” rule, scrapped in 2007, allowed short selling – where traders profit from price falls – only when the last tick in a stock’s price was positive. There are now growing calls to bring the rule back amid continuing turmoil in the stock markets.

Mary Schapiro, the SEC chairman, has said that examining the rule was one of the things she was “committed to doing very quickly.” Barney Frank, a leading Democratic congressman, told reporters on Tuesday that he was “hopeful” that the uptick rule will be restored “within a month.” Christopher Dodd, chairman of the Senate banking committee, also endorsed the plan.

“The Commission may conduct a public meeting as early as next month to consider whether to formally propose reinstatement of the uptick rule, or consider other measures related to short sales,” the SEC said on Tuesday.

However, some market participants have argued that the uptick rule have had little or no demonstrated benefit in the past.

Almost six months after market watchdogs around the globe banned short selling of bank stocks, some big markets have since relented and allowed investors once again to bet on price falls.

But bans remain widespread, if mainly in countries with small stock markets. Germany, Italy and Australia are the biggest to retain bans, followed by South Korea, the Netherlands, Ireland, Norway, Denmark and Greece.

All share a fear of what Silvio Berlusconi, Italy’s prime minister, called “speculative attacks” on banks.

However, academics and hedge funds believe the measures failed miserably. Rather than protecting banks and other financial institutions, many failed even while they were protected from short selling.

Those which did not fail generally saw their shares plummet. Since September 19, when the UK’s Financial Services Authority led the way with the first ban, European banks have plunged 65 per cent, while US banks are down 73 per cent.

A study commissioned by London’s investment banking, hedge funds and stock lending trade bodies found that stocks subject to the bans had much the same performance as those without restrictions.

Even Lord Turner, chairman of the FSA, commenting after sharp share price falls in the days following the lifting of the ban, said there was no evidence that the falls were due to a big increase in shorting.

Still, regulators and politicians continue to worry about the possibility of co-ordinated shorting designed to drive down a bank’s shares, damaging confidence and sparking a run – although none has presented any evidence of such illegal conspiracies.

Hedge funds argue they are unfairly demonised for putting money behind their negative views. Far from driving down the price in order to damage banks, they contend, the banks were damaged through subprime and other dodgy lending and all the price falls are doing is reflecting reality.

“These bans are all worthless,” one European hedge fund manager said on Tuesday. “But at least it seems it is no longer the fashion to do it.”

Even countries which dropped bans have imposed tighter rules on short sellers.

The UK, France and Spain demand public disclosure of big short positions, making some hedge funds think twice before taking positions. Others, including Japan and France, have banned “naked” shorting, the practice of selling shares without first borrowing them, in the hope of buying them back before the first trade settles.

The Australian Securities and Investments Commission (Asic) said its decision last week to extend a short ban for almost three months was justified because financials “are so integral to our market here”.

Additional reporting by Lindsay Whipp in Tokyo, Robin Kwong in Taipei and Joanna Chung in New York"

"But this turns out to be dangerous hysteria, disconnected from the trading facts. "

Peston on BBC:

"When the ban on short-selling( ASININE ) was introduced last year, the chancellor basked in the general approbation of this crackdown on financial speculation that was supposedly destroying confidence in our banks.

The impression was created that the Treasury was in part responsible for the prohibition on the practice of borrowing bank shares to sell them (with the speculator hoping to buy them back later at a lower price to trouser the difference).

Which now puts the government in something of a pickle. Because it's very unhappy that the City watchdog, the Financial Services Authority, lifted the ban last Friday on these transactions that generate profits from falling share prices.

But ministers can't easily express their disapproval in public - to do so would imply that they didn't really have much say in the imposition of the ban in the first place.

The thing is that the FSA is an independent regulatory body. And at least part of its role is to promote liquid markets that set prices in an efficient way.( YES )

The FSA believes that short-selling enhances the process of setting prices, by capturing the available supply and demand for securities and also relevant information.( I AGREE )

As we surely must now appreciate, as we live with the bitter consequences of the popping of the debt bubble, the euphoric buying of assets by manic investors is highly dangerous - so it can be very helpful that the market contains short-sellers expressing a contrary, negative view.( YES )

So the FSA would only ban short-selling, or any other similar orthodox and longstanding trading practice, when it detected palpable, significant damage to companies or to the economy that outweighed the market benefits.

There was evidence of such damage last spring and summer. A vicious interaction of malicious rumour and speculative sales was devastating bank share prices, and this in turn affected the confidence of banks' creditors and depositors.

When these creditors and depositors withdrew their funds, banks came perilously close to collapse, which transformed the rumours into self-fulfilling propositions.( BUT THE CALLING RUN WAS ENTIRELY SEPARATE )

The ban on short-selling was therefore a circuit-breaker between rumour and the undermining of banks' ability to fund themselves in the wholesale money markets and from retail deposits.

However, since the ban was imposed last autumn, the funding of banks - their borrowing - has become much more stable, thanks to the forced largesse of taxpayers.( YES )

The Treasury has committed around £800bn of taxpayers' money to underpin banks' ability to borrow what they need. A run on a bank that would bring it down is almost impossible today, because banks can secure what they need from us, the taxpayers.( YES )

Which is why the FSA felt comfortable about allowing short-selling to re-commence.

To put it in stark terms, thanks to taxpayers' largesse, short-selling bank stocks is no longer a potentially lethal activity.

Even so, many - including ministers - argue that the FSA was crackers to allow short-selling to start again.

They point to the collapse in the share prices of Royal Bank of Scotland, Lloyds Banking Group and Barclays as evidence that hedge funds and other short-sellers are up to their old tricks of destroying the infrastructure of the British economy for private profit.

There's only one problem with this thesis: it's not supported by the facts.( TRUE )

Since the ban was lifted, there has been a negligible amount of short selling.

And although some will be revolted by the disclosure in this morning's Guardian that Landsdowne has made a few millions in profit from shorting Barclays, it's laughable to think that Landsdowne's miniscule short position could have contributed to the billions wiped off Barclays' value since last Friday.( SILLY )

Most of the share price movements in the big banks have been caused by conventional selling of shares by the normal gamut of investment institutions.( YES )

Some of these investors may have sold because of their conviction that the shorts were selling the stock down to zero. In fact a number have told me precisely that. But this turns out to be dangerous hysteria( YES ), disconnected from the trading facts.

There is an argument that the FSA should have anticipated this irrational depression( TRUE ) on the part of pension funds and others - and should have delayed the lifting of the ban until a bit more common-sense( MAYBE ) returned to the market.

But the main cause of the recent falls in bank shares was the Treasury's massive new package to stimulate lending - which spooked the City for reasons discussed in earlier notes - and a worldwide escalation in fears about the health of banks.( YES )

The short-sellers are the convenient whipping boys, not the prime malefactors (if you think it's a crime that the share prices have fallen, which is moot).

As of now, no irredeemable damage appears to have been done. And although it may jar to say so, shares can rise as well as fall - even bank shares. "

I think that the short selling ban was a mistake, which might have helped calcify the market.

Short-Selling Ban Bust

I said in an earlier post the following:

"So, now you have both sides. I see both sides, but have to agree with bonddad in this case because I hate this back and forth of rules and legislation brought on by a crisis. If we're going to have the rule, keep it. On the other hand, I don't see suspending it for a short time as the end of the republic either."

I then did a post on Meghan McArdle saying more or less the same thing.

I didn't say anything about the short-selling ban, largely because I felt exactly the same way about it. I didn't see the point of doing it, other than making it look like the SEC was doing something, which, for all I know, matters, but I didn't see it as ending the republic either.

However, Brian Doherty of Reason seems to have been correct. Read this post which also has a good explanation of short-selling. Here's a piece:

"Most people who short are not doing so out of any attempt to drive a price down; many of them, including huge hedge funds, are often doing so merely to hedge risk when they are otherwise imbedded in transactions that depend on asset prices going up. So, if the SEC tries to make the ban more permanent, they are limiting the ways actors in the economy can cover their risk and spread information—both bad things.

But whether or not the short sell ban continues or even becomes permanent in some form, damage has already been done. The real problem is the sort it might take a Debord or Vaneigem to fully parse: it’s that SEC chief Chris Cox and those who think like him have taken upon themselves, publicly and with violent quickness, to show that they are in charge of social and economic reality, able to reshape it to their desires with their will and imagination; that common and sensible practices whose overall effect is to reveal economic reality more quickly and smoothly are to be halted at their command."

Now from today's NY Times:

“There’s liquidity out of the marketplace,” said H. Seth Berlin, the principal at Performance Thinking & Technologies, a hedge fund consulting firm. “Did the ban really do what it was supposed to do? Probably not.”

Some investors said that bringing short-selling back to the market could actually bolster stocks. Andrew Fishman, president of Schonfeld Group, an asset manager in New York, said that some of his clients wanted to exit short positions in recent weeks, which would have meant purchasing shares, but they did not do so because they feared they would not be able to borrow the stock again to short it later on.

Mr. Fishman said short-selling has been wrongly blamed. The real problem, he said, is the weakness of financial institutions.

“You can never change the path of a stock,” Mr. Fishman said. “If it’s going to go down, it’s going to go down.”

A tentative conclusion: It didn't help, and might have hurt. More to follow.