Last week we wrote about some of the suspicious activity we had noted in the stock market and how former presidential candidate Mike Huckabee made comments on that activity. This week we want to expand on that theme as we believe most investors are unaware how they may be at a distinct disadvantage when investing in our stock market.
One of the more egregious forms of manipulation has been naked short selling. Short selling is a legal strategy that involves borrowing shares of stock from someone, selling it, buying it back, and returning the shares to the lender. The strategy is to sell high and buy low rather than buy low and sell high. The naked short seller does not bother to borrow the stock, they just sell it, diluting the number of shares outstanding. The more supply usually the cheaper the asset.
You may recall that a couple of times this year the SEC jumped in and said in order to short specific financial institutions, it was a requirement that the shares be pre-borrowed. Previously the institutional short seller just had to tell his broker that he knew where the borrowable shares were (retail clients have to depend on their broker to find the shares and if they can’t, the trade cannot be done). After these changes were announced the shares of these financial institutions firmed significantly. When the constraints were removed the stocks dropped again.
What is puzzling to me is that the SEC was changing the rules that were essentially already in place, they apparently did not enforce those rules. At least that is what many seem to think . Jim Cramer is an ex-hedge fund manager who has a show on CNBC called “Mad Money.” He has constantly leveled criticism at the Fed, and the SEC for not being in front of several issues. He claims that those institutions are filled with academicians and attorneys who have never managed money or worked in the industry. The Treasury does appear to be the follow on career move for Goldman Sachs officers.
Last week Cramer, as he likes to be called, described in detail how the short sellers were able to manipulate the price and news flow of the stocks of some of our major financial institutions. He claims that this process brought down Bear Stearns and Lehman Brothers and nationalized Freddie Mac and Fannie Mae. Here is a link (Cramer's Short Circuit) to his describing of this process. It is a 13 minute clip and his description of the process starts at minute four. I think for any investor it is a must listen to.
We have heard that if we not only stop the abusive naked short selling and also reinstitute the uptick rule (the uptick rule allows you to short a stock only when the stock ticks up in price, it prevents bear raids and is also mentioned in the clip) we could have a sizable rally in the stock market. We definitely do need a cleaning up of Wall Street and hopefully if you get a chance to watch the clip you will be a little more enlightened about how some things work there. We imagine this will be a priority for the next administration. We think as a country it is important to revere the financial industry as so much rides on the investor confidence. Unfortunately it appears to us that some felt personal gain was worth compromising our financial system. As we said last week if the investigation trail whiffs of terrorism, something needs to be done about this in a hurry.
What we hope to see come out of this mess is those who violated securities laws are thoroughly prosecuted and penalties put in place to deter future abuse. A $1million fine to someone who made $20 or $30 million is the cost of doing business and not a deterrence. We feel what we do not need is more regulation (remember the paperwork to open your last brokerage account?) but strict enforcement of the laws that are already in place. We also would like to see like to see all the naked shorts (also called counterfeit shares) have to be covered as the SEC rules indicate combine that with the reinstitution of the uptick rule and you might have the Dow above 10,000 again. Remember those days?
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