Ban on Short-Selling Will Hurt Rather Than Help Broker-Dealers

New measures to shore up the markets are coming so fast and furious that it is becoming hard to keep track of them. What most people do not realize is that they produced some not-very-pretty unintended consequences. As we discussed (courtesy reader Lune) at the time:

1) Congress raises conforming limits on Fannie/Freddie to help unfreeze the mortgage market. Result: agency spreads skyrocket, bringing down Bear and a host of hedge funds. Mortgage markets still remain frozen.

2) Fed opens TSLF to unfreeze mortgage market. Result: Carlyle goes bankrupt as people rapidly arbitrage the difference between holding MBS in firms that can and can’t access the new credit facility. Mortgage markets remain frozen.

Note the spike in agency spreads and bankruptcy of Carlyle helped precipitate the run on Bear.

In fact, as Richard Bookstaber discussed at length in his book, Demon of Our Own Design, this sort of unintended consequence is precisely what you’d expect to see in a tightly coupled system, such are our financial system. Tight coupling occurs when processes move from step to step so rapidly that intervention is well-nigh impossible. Bear Stearns and Lehman are classic examples. A downgrade of their debt beyond a certain level meant that their counterparties could no longer trade with them, because that exposure would get them downgraded too. Thus a move (or threatened move) beyond a trigger point kicked off a sequence of unstoppable events.

One possible consequence is that hedge funds forced to exit positions by the SEC ban on short-selling might take losses big enough to lead to a run of the fund, forcing liquidation of positions. That rapid selling could produce distressed prices, and in a worst-case scenario, brokers could take losses if collateralized positions fell in value and hedge funds were unable to meet margin calls.

Note Morgan Stanley and Goldman are far and away the biggest prime brokers.

John Hempton sets forth another unintended consequence which is more certain to happen and broader in its impact and puts none to fine a point on it in his post title, “SEC Tries to Bankrupt Wall Street“:

Last I looked when I was short a stock the broker borrowed the stock (yes, Virgina you do get a borrow) and sold it. They then had cash.

That cash was not available to me – it was pledged to whoever provided the stock to remove or reduce the risk that the stock won’t be returned.

That means it is generally available to the broker (who will generally lend me the stock from their inventory or margin or prime broker clients).

Now there are a few hundred billion of short-sales out there. Probably more than normal – but a lot in almost all markets.

And those short sales produce cash balances of a few hundred billion, most of which are available to Wall Street brokers.

If you ban short-selling those balances will taken away from Wall Street brokers.

That would be rather unpleasant. Last I looked the debt market was skittish and was hardly going to replace that money.

So I conclude that the SEC in their “infinite wisdom” are going to stick the knife into Wall Street and bankrupt the lot of them. For political optics. So they can be seen to be doing something about short-selling.

The only reason the damage might not be as broad-scale as Hempton fears is that the “temporary” ban is on shorting financial stock. Oh wait, financial represented (until they started hitting the rocks) 40% of S&P earnings.

And there is something far simpler that the SEC could do. Just re-implement the uptick rule (it means you can short only when the last sale price was above the immediately prior sale). That rule comported itself well for over 50 years but for some unfathomable reason (no doubt at the behest of Wall Street) was eliminated b the SEC.

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  1. vikas


    great site. I lurk constantly.

    Thank god they haven’t banned independent financial commentary (yet).

  2. Anonymous

    Ms. Smith: I wonder, would it be possible to arrange it so that accessing a site on your blogroll would result in separate window opening up? Other sites do this and I think it would make it easier on your followers as well as making your site a bit “stickier,” as they say.
    You really do turn out terrific stuff, I want to say again. Thank you.


    C. Neil

  3. Anonymous

    Great post Yves…

    Here is a (theory, question, rumor?) from Barry Ritholtz… ‘Then there is another coincidence: The huge increase in shorting of the financials occurred on the anniversary of 9/11. And on top of that, the same institutions attacked on 9/11/01 were the ones suffering in recent days.

    Joe asked the question: Is anyone investigating whether this is a case of financial terrorism? He wanted to know if someone was at least looking into this question (Joe is buds with Jim Cramer, and mentioned it to him, who then omitted to cite in his column that this was Joe’s theory, not his own.’

    This could be another case of ‘blame it on the terrorists’…imo.


  4. elizabeth

    I sent the following email to my congressman this morning:

    I have a Palo Alto-based independent financial planning and advisory business.

    I have watched in dismay as the government has continually tried to stick its finger in the dyke to stanch the upheavals in the financial markets.

    The financial sector has been dangerously out of control for a number of years and the effort should not concentrate on saving flawed business models but averting collateral damage such as the inability of high grade non-financial firms to get credit.

    The SEC’s blanket ban on short-selling of financial firms is beyond insane.

    The maintenance of open and freely trading markets is a cornerstone of our economy. This is a bizarre attempt to protect the equity holders of financial firms, some of which don’t need protecting and some of which don’t deserve protecting.

    I would remind you on the other side of every short sale is a willing buyer.

    The government is changing the rules in the middle of the game. Transactions have been made that rely on the basic rules remaining the same.

    I spent years as a trader on Wall Street but I would consider myself politically quite liberal. I am appreciative of free and open capital markets yet aware of how they can go bad when unchecked.

    I believe substantial reform of virtually every aspect of our financial system is vital but banning short-selling is one measure that should not be employed.

    Managers of financial firms who have made poor decisions should not be allowed to scapegoat a practice which has been a fundamental part of our markets in the modern era.

    If your office has any questions as to why this is a terrible mistake, I would be happy to answer questions or give a primer on the role of short-selling.


  5. Dean

    From a macro POV the two major underlying trends continue unabated.

    First housing values continue to decline and second we are entering a good size recession.

    Therefore, I don’t understand the curative value of the proposed solution (BTW I think the half Trillion medicine will quickly become a 10X pound of cure).

    The only reasonable conclusion I can draw from this is that the crisis is far deeper and more pronounced that anyone could have ever thought possible.

  6. Anonymous

    I don’t see how the US market can function without shorts. Where will liquidity/purchasers come from to prevent huge open gaps? I realize that there are markets that (function?) without shorts but how will the US market, which is structured for shorts/longs provide orderly trading?

    This ‘no shorting’ rule seems to be the most desperate of measures so far.

    Glad I got outta stocks in ’06. We might see another move into the commodities playground.

  7. Anonymous

    With short selling banned, purchasing put options and selling calls remains a viable way to place bets on assets prices continuing to drop, albeit one that requires a greater degree of financial sophistication and an ability to stomach high amounts of volatility.

    I presume that long-short hedge funds will be increasing their trading in options. Good news for those brokerage companies that specialize in option trading.

  8. Anonymous

    C. Neil:

    To have a link open in a new window, right-click (option-click on a Mac) the link and pick “Open Link in New Window” (or some similar wording) from the pop-up menu.

  9. William Mitchell

    Hear hear, reinstate uptick rule. As I commented yesterday in CalculatedRisk:

    Yes, it’s a mistake to ban short selling outright.
    Yes, short sellers are unfairly maligned.

    What they should have done is to reinstitute the short uptick rule, which Mr. Cox repealed in summer 2007 after 70 years in force.

    This would eliminate a legitimate problem: bear raids on financial firms during a general market panic. These differ from regular short selling, in that you can actually destroy the business fundamentals just by moving the price, creating a self-fulfilling race to the exits.

    This is why the short uptick rule was originally created. It was an elegant, non-invasive way to slow coordinated short selling without banning it outright.

    We should listen to the listen to the lessons of the Great Depression, or be doomed to relearn them.

  10. LJR

    C. Neil:

    If you use Firefox just click the middle mouse button to open a link in a new tab.

    Check the Tabs folder in Options to make Firefox switch to the new tab as soon as it opens.

  11. mxq

    Investors are still able to short etf’s, so the intended consequence of banning short selling in financials is clearly going to be mitigated.

    As Yves mentioned, the uptick rule would’ve gone a long way (and in fact is time tested), to comprehensively bring order back to the market.

  12. doc holiday

    This may not be the right place or time, but Treasury/Bush et al, really need to privatize Social Security before the market in Japan opens Monday!! This is a critical dream of Bush, so … why not take this insanity a few more steps each day until we get Rome looking like the smoking end of Fidel Alejandro Castro Ruz cigar?

    We need more wall street cowbell before the Bushies leave office!

  13. Dan

    Did anyone else just hear Bush say that those engaging in short selling would be caught and PERSECUTED? Hoping that was just a freudian slip… no need to start waterboarding hedge fund managers yet (although….)

  14. Matthew Dubuque

    Matthew Dubuque

    With respect to Bookstaber, I would point out that the rate of financial coupling has been amplified DRAMATICALLY due to technological factors such as email, real-time quotes and text messaging linking us all in hypertime.

    Corrigan first discussed some of the risks associated with this coupling in the 1980s during his legendary stint at the NY Fed.

    Matthew Dubuque

  15. mxq

    If we put this into perspective by saying the modern financial system – not just the equity market – was on the precipice of collapse yesterday (and could’ve probably collapsed today), does it change the perception of today’s actions?

    If the system collapses, you can’t short sell anyways, you can’t borrow, you can’t have a mmkt account, no debit card, no checks, no credit cards, you maybe can’t even have a mortgage…you can’t do anything. As cramer said on cnbc, you probably start bartering.

    If that’s the end-game – short, long, flat – i’m open to whatever it takes to not let that happen.

  16. Speaker73

    “With short selling banned, purchasing put options and selling calls remains a viable way to place bets on assets prices continuing to drop, albeit one that requires a greater degree of financial sophistication and an ability to stomach high amounts of volatility.”

    The problem is that put sellers then sell the underlying equity to hedge their delta, effectively putting on a short position. I have not read the gov docs, but I assume they have left a loophole for this, otherwise it will be impossible for anyone to sell options, since they will be unable to hedge their risk.

    Regardless, this is a disastrous idea. It may pump the market in the short-term, but if there is bad news down the road, the natural buyers in a down move have been removed. That means illiquidity which leads to crashes.

  17. doc holiday

    > How do you rate the job Melvin L. Watt is doing as Representative…._Watt/ comments


    Oversight and Investigations
    Chairman Melvin L. Watt (NC) leads the subcommittee, which conducts oversight of the agencies, departments, and programs under the Committee’s jurisdiction. The subcommittee also conducts investigations on any matter within the jurisdiction of the Committee, and evaluates the need for any legislative changes to the laws and programs within this jurisdiction.

  18. Alan von Altendorf

    I just looked at Reuters option quotes for JPM. Totally screwy. And the S&P, Russell, etc indexes don't have any ask quotes. I think we better ask an options trader what the heck is going on.

  19. Anonymous

    “The problem is that put sellers then sell the underlying equity to hedge their delta, effectively putting on a short position. I have not read the gov docs, but I assume they have left a loophole for this, otherwise it will be impossible for anyone to sell options, since they will be unable to hedge their risk.”

    Wrong. Put sellers can hedge their risk by buying calls, or through the long side of total return swaps on equities, or other derivatives.

  20. Anonymous


    Bethesda, MD, September 19, 2008 – Due to the emergency action
    announced by the Securities and Exchange Commission on September 18,
    2008, temporarily prohibiting short sales of shares of certain
    financial companies, Short Financials ProShares (SEF) and UltraShort
    Financials ProShares (SKF) are not expected to accept orders from
    Authorized Participants to create shares until further notice. Unless
    notified otherwise, shares will be available for redemption by
    Authorized Participants as normal. The shares of these ProShares are
    expected to continue to trade in the financial markets today, but may
    trade at prices that are not in line with their intraday indicative

    Media contact:
    Tucker Hewes, Hewes Communications, Inc., (212) 207-9451

  21. Marcf

    I am not as negative as many here or even YS. As pointed out the short selling is restricted to financials and temporary. The problems with Shorts is that they amplify trend in a feedback loop. Removing them during distress is worthy. The bollocks I read here about liquidity available to banks due to the short-sellers money in escrow and the profit they derive from that (what OverNight rates?) is PEANUTS compared to the damage the shorts were doing amplifying trend. I mean think about it, Lehman was bled to death while a solvent bank in a matter of days. Shorts are UZIs and should be banned when martial applies in the markets (as it does now). As someone else pointed out, derivatives are a good way to trade these markets. Their impact on the stock is real but not first order like and outright sale or stock dilution. Finally also as pointed out, this will not revert the trend but will make the slope manageable. At least that is what is hoped.

    VERY interesting point about “connectivity” this is the first crisis in earnest during the internet era… what has the internet impact been? hmmmmm…

    Give the new lords of USSRA some time to adapt!

  22. a

    “The problem is that put sellers then sell the underlying equity to hedge their delta, effectively putting on a short position. I have not read the gov docs, but I assume they have left a loophole for this, otherwise it will be impossible for anyone to sell options, since they will be unable to hedge their risk.”

    In Britain the rules are clear that (for now at least) “market makers”, including those financial houses which trade and hedge derivatives, may short stocks.

    In the US it is less clear, and at the moment it may be that even derivatives houses cannot short sell any stocks on the list, which will mean that for those stocks they will need to hedge otherwise (e.g. futures, stocks where they are long, etc.). This will certainly make it difficult to hedge and trade options and other deriviatives for those stocks where the house would be in short sell.

  23. fred55

    well i have read the documents and i am a securities lawyer but you dont have to be to read them, theyre remarkably clear

    as of 1159 pm today option market makers are not permitted to short.

    period end of story.

    no short, no put options.

    or the put options are available only by matching naturals.

    and if they go up huge in price, that means the call options must go up in price by parity (arbitrage will guarantee that they do).

    and black scholes cannot price this because it assumes continuously trading liquid and complete markets

    so for the time being there will be no options market in these stocks.

    anyone who doesnt understand what i just wrote is not qualified to trade options, seriously, and i say this for your own protection.

  24. Cash Mundy

    Avast, ye scurvy short-sellin’ dogs! Heave to an’ strike yer colors, or ye’ll be boarded and scuttled! An’ there’ll be no mutterin’ about any of the financial pirate-ships which their capn’s is friends with the Cap’n, or I’ll run ye thru, so help me I will! Now shove off an buy financials or its tied to the cathead and 40 lashes for you, an yer grog stopped for a month, ye mangy pack of sea-lawyer scrubs!

    Today is officially

    Talk Like A Pirate Day 2008

    In fact,
    September 19th falls on a Friday this year, so folks are making plans for an extended Talk Like A Pirate weekend. Let us know about yours!

    It’s just that simple, folks!

    My brokerage house is acting weird on the Net today. Can’t do this, can’t retrieve that, something else timing out. Are they being boarded and scuttled? My SKF and SRS have been burnt to the waterline, so
    where’s my bailout? Everyone else gets a bailout, so I want one too! WAAAAAHHH! WANT BAILOUT NOW!!!

  25. The National Bureau of Standards

    Bulletin from the National Bureau of Standards

    Negative numbers are banned in the United States with immediate effect. Or ye’ll walk the plank. Positive integers are deprecated, an only a damn sea-lawyer would use’em anyway.

    Irrational and Imaginary numbers are now the Official Numbering Systems (ONS) of the United States.
    Capn’s orders and no back-talk.

    An announcement from the Bureau of Engraving and Printing regarding changes to the currency of the United States will follow.
    Pieces of eight, me buccoes, pieces of eight!


  26. fred55

    remember, again, options pricing models do NOT NOT NOT generally incorporate what we call jump conditions (im also a quant).

    a jump condition is what you saw overnight.

    to compensate for that, market makers add in extra premium, which is reflected in implied volatility, and if you plot that against strike price you will find that the out of the money options are much more expensive to reflect the fact that 6 sigma events occur more frequently than the models say. they learned this in 1987.

    long a call and short a put must exactly replicate the carrying cost of a long position 100% financed, or something is wrong. this is called a synthetic future for that reason.

    puts go up in price because of the scarcity premium, calls have to go up too or you could buy the call, sell the put, sell the stock you already own, and pocket a risk free profit.

    now if you are a market maker on EUROPEAN options, and equity options are typically american, you can build in a cost of a two week delay in dynamic hedging, but it will be huge. huge.

    and we dont even know it will go off in two weeks (i believe its timed to coincide with congressional vacation).

    no one will transact short equity swaps either, or single stock futures, because they have to be hedged as well.

    there are always naturals who hold puts and may sell them. in fact i would imagine the bid on october puts on these stocks is huge.

    except on cboe there are maximum spreads, which i think would be $2 or $4.

    of course the response to that is to have thin liquidity; market makers are only required to trade 10 or 20 (i forget) of what is quoted.

    all of this can be suspended in fast market conditions.


    as to skf.

    no clue here because while it HAS to be the case that skf stops offering new shares, it has to stop redeeming them too i would imagine to preserve capital.

    whether it stops redemptions or not, i doubt they have perpetual derivatives on, meaning sooner or later their derivative positions have to expire.

    right now, i would imagine the mark to market value of skf is way way higher than it should be because of the built in premium (see above) on those derivatives, which premium will be subject to theta (time decay).

    so they cant redeem at mark, that will deplete capital, and if their prospectus doesnt allow it they cant redeem at other than mark.


  27. mxq

    Ritholtz pointed out an interesting theory today that might explain (assuming it can be explained at all!) the SEC’s overreaction to short selling…he reported that US hedgies were not pushing shorts yesterday and that a lot of order flow for shorts was actually coming from foreign bourses.

    In addition, there was a spike in short selling on the anniversary of 9/11 this year.

    Given the regulatory vacuum in the CDS market, I’m wondering if it is really hard for someone to short a stock and simultaneously buy a cds (pushing out spreads)?

    The occurence of financial terrorism is totally unverified, intellectually disappointing and could well be just another conspiracy theory, but its no more credible than assuming there are secret political agendas at work.

  28. Anonymous

    “Given the regulatory vacuum in the CDS market, I’m wondering if it is really hard for someone to short a stock and simultaneously buy a cds (pushing out spreads)?”

    Yes, because CDSs thinly traded, it is possible to enter trades that push spreads. Some people have been accusing hedge funds of manipulating CDSs.

  29. a

    fred55 – I should have said it was less clear to me; being dereft of reading ability, I don’t read the original document and do what I’m told. We were told we could, then we couldn’t. That was what was not clear.

  30. Anonymous

    foreign bourses — [money capital has no nationality]

    financial terrorism — [the draw made by financial capital against productive labor and the value it creates which, becoming insufficient, came to include the world financial sector’s progressively greater and necessarily self-destructive demand on itself. system failure ensues. blame must be placed where it belongs]

  31. Steve

    Options group slams SEC short-sales ban
    Fri Sep 19, 2008 1:54pm EDT

    CHICAGO (Reuters) – The SEC’s emergency order to ban short sales of many financial stocks will have “potentially disastrous effects” on the U.S. listed options market, the head of the Options Clearing Corp said on Friday.

    “As written, this order does not allow for an options market maker exemption to ensure liquid and orderly markets starting on Monday. This will have dire consequences on the U.S. equities markets,” Wayne Luthringshausen, chairman and CEO of the OCC, said in a statement.

    The OCC is the world’s largest equity derivatives clearing organization.

    (Reporting by Ros Krasny)

  32. Anonymous

    Philosophically speaking I never quite understood why countries can have markets open for foreign investments, but require Visa’s to travel there or, even have ‘closed borders’, but open trading.

    As for financial terrorism – my undocumented belief is that the markets were doing a phenomenal job in propping us up after 9/11 and this is the fall-out. However, that said, someone once told me that, “if you smell something bad, smell yourself first.”

    Therein: if it is financial terrorism, we have only ourselves to blame.

  33. doc holiday

    Bill Gross, chief investment officer of Pimco, said he is interested in managing a pool of assets acquired by the government through recent financial rescue plans.

    >> Why not Yves?

  34. Anonymous

    Suing the US government?

    Can I sue the government over this fiasco? This is YVes’s Bannana Republic at work. I see my tax dollars being used to float the balance sheet of individuals who profited enormously from all these shenanigans. It is a seizure of
    my personal wealth!

    I get nothing out of this deal. Can someone please throw me a bone on my personal debts???

  35. Steve

    That was quick — looks an exemption for option market makers is coming:

    Statement of SEC Division of Trading and Markets

    Washington, D.C., Sept. 19, 2008 — The Securities and Exchange Commission’s Division of Trading and Markets today issued the following statement:

    “The Commission staff is recommending to the Commission a modification to its order prohibiting short selling in securities of specified financial firms. This modification would extend, for the life of the order, the exemption for hedging activities by exchange and over-the-counter market makers in derivatives on the securities covered by the order.”

  36. Anonymous

    I get nothing out of this deal. Can someone please throw me a bone on my personal debts???>>>

    let me tell you a little story of my childhood…

    broke due to the incredible 1970s which we'd much rather forget; yes, the oil embargo, when my mom stocked up on sugar (sugar?) and we wore threads while trying to hold on to our house.

    my mom, indebted out her ears, made deals with EVERYONE including our Doctors. She simply said, I can pay you $10 a month on the 15th exactly. and guess what – she did exactly that. she also bartered, and, for a time, had her own maid service while my father wore a suit and went to work at a brokerage firm.

    so, there's your bone, there ain't no meat on it to be sure, but its a bone nonetheless.

  37. mxq

    “I never quite understood why countries can have markets open for foreign investments, but require Visa’s to travel there or, even have ‘closed borders’, but open trading.”

    I’m not sure that understanding is correct. For example, foreign bourses merely access the liquidity provided by US markets, but settlement and terminals are located in the foreign country.

    As far as mitigating the potential for US based-terrorits funds, FinCEN , for example, attempts to achieve a similar end for capital as a Visa does for a person.

    So I’m not sure the funds that are potentially manipulating the markets are actually housed in the US, per say. Given that FinCEN has no jurisdiction in foreign countries, the only way the US could “defend” itself from a financially driven terrorist attack is by closing the only route that is potentially being abused — the short selling route.

    Again, I’m not saying it was a good idea to do this, I’m merely saying, if financial terrorism is involved, what we saw today would, imo, be excusable.

    However, anything short of that is abominable.

  38. Anonymous

    September 19, 2008

    Has anyone else notice how easily “Trillion” roles off the tongue beginning about the middle of March 2008? In this recent updating of the USA English lexicon on would think that adding a $Trillion or so rescue plan to the Social Security System would pass in the blink of the eyes if some shy Dem. added it to an also Dem sponsored bill establishing a “National Republican Day”. I would choose July 5th as the subject date so we might then get a 4 or 5 day holiday. We’re going to need it.

    On the Beach

  39. ruetheday

    CNBC reporting details of the plan are coming out.

    The gov’t will buy mortgages, MBS, and CDOs via auctions.

    Hedge funds will not be eligible to participate. Nor will any foreign firms.

    The “buy” part of the program will last two years and then close. The gov’t will hold the assets beyond the two years.

    So how does that work? What prevents hedge funds and foreign firms from selling these securities to eligible US banks to offload on the gov’t? There’s arbitrage opportunities all over the place.

  40. Anonymous

    Ye vast me hearties, evoke the code or she strike the reef and ye be bail’in old salty all thee way down til davy jone’s locker.

  41. Anonymous

    Sure, you get something out of this…..instead of National Tax Freedom day (the day you completed paying all projected tax obligations for the current year) being measured in months, it will be measured in years.

    Argggggggg!! We’ve three sheets to the winds an a broken tiller.

  42. Anonymous

    September 19 2008

    To the “Blog Pirates”:
    Kudos for your posts. Most would say that it would be a mistake to encourage you in any way, but I find that your more outrageous, and therefore humorous, post are one of the few things that keep me from slashing my wrists. Ohh! One more thing. You might want to add a reference to the land lubber’s expression of “Not a pot left to pee in.” I’m not a sailor, and since you have the whole ocean to pee in, I am at a loss to come up with the appropriate pirate’s phrase.

    On the Beach, and Near to the Harbor.

  43. A Blog Pirate

    Earl, me bucko,

    Behold us and despair, matey, for we are the light entertainment at the end of the tunnel, followed by the train.

    So batten down the hatches, strike down the topmasts, and splice the mainbrace. The Crimson Permanent Assurance has hoisted the Jolly Roger!


  44. Anonymous

    “Ban on Short-Selling Will Hurt Rather Than Help Broker-Dealers”

    Oh is it ? Thanks Yves. We PhDs at NY Fed didnot knew abt it.

    Lets call BEN and HANK and put them on line with Yves.

    NS Capital Partners

  45. a

    Doesn’t this throw a big clinker into two of the most popular hedge fund strategies, long-short and merg arb? With long-short you obviously have to short something. And while one can still do merg arb on cash deals, stock deals require selling the stock of the buying firm.

  46. Richard Kline

    So LJR and all, I would happily have commented on this on the front end, but I go to bed effective at 1000 hrs EST, so I juussst missed Yves post here.

    But from a systemic standpoint this is a Very, Very, BAD Thing, this sudden ban on shorts. Consider a system with high velocity, high volume, and many coordinated components, but with a linked rather than governed relationship. If one abruptly _immobilizes_ a linkage process while making no other changes, the outcome is likely to be, literally, explosive. Velocity doesn’t just stop elsewhere in the system; volume doesn’t just freeze elsewhere in the system—both back up until either or both blows out the weakest node in close proximity. How that happens and how fast depends on the system, but sudden freezeups are literally catastrophic events from the standpoint of highly linked systems. Think about would it would mean to try to stop all motion in the chain of a bicycle moving at high velocity while everything remains linked. Not only does the rider keep moving sans bicycle, but the bicycle destructs a crucial component.

    Or consider a Concorde up to speed and altitude, but in turbulence a major problem crops up: starts sticking up so that the behemoth keeps edging into a hard right role which the pilot has to fight to control. This SEC ban is the equivalent of forcing the elevator all the way down and welding the control line linkages frozen. The only question after that is whether you crash first or whether the tail assembly tears apart and then you crash.

    —And in effect, this is just what happened: The SEC blew up the CBOT. I mean the two hated each other, but this is an indescribible FUBAR. Now, I don’t claim for a second any competence in options, derivatives, puts, calls, or the rest. Let’s leave it to fred55 and others to describe the _specific_ plays on this. But I will speak to generic issues. Shorts are completely integral to how contemporary financial markets work. Colossal sums are linked to shorts and the hedges built around them. Even supposing that this fool rule change is changed, think about what it would mean for the _volume_ of shorts here to be taken off and re-established in puts and calls. The least that one could say is that such an attempted transformation in present market conditions is inherently extremely _destabilizing_. I suspect that it won’t be possible to pull off, and that it will be the derivative markets which are the systemically weak link which will blow out in the process. The uptick rule would be far, far better. It is a buffer rather than a hard bar, which is inherently more systemically forgiving, and still allows action. Furthermore, it is self-regulatory on the basis of node-specific feedback in real time (price discovery of the basic positon), exactly the kind of governing structure one hopes for in massively connected systems. Who was the idiot who took it off? Exactly the idiot who refuses to lose face by putting it back on but instead catastrophically and rigidly over-intervenes in the system now.

    I wonder if the impact of multi-trillion positions cracking up will lift all of us a few feet into the air? If so, it might feel briefly like the Rapture, but we can call it the Rupture. I have no position on whether this will actually occur, but the short ban is the kind of systemically stupid action which has a non-neglibible chance of precipitatiing it.

    . . . When the history for this financial crisis is written, and major participants are ranked for the cometence of their actions from the Good, to the Bad, to the Fugly, down beneath the bottom of the pile, below the concrete in the last sub-basement, down below the groundwater seep of the deepest septic tank we will find Christopher Cox wedged head first into bedrock. Nothing he has done in his tenure has been anything other than actively destructive in a manner betraying 0% competence and 100% concupiscence with the markets he is supposed to regulate, and of all his actions this one is the _worst_ by an order of magnitude. I have an analogy for what should be done with HIM by Monday morning Tokyo time, but since that might be construed as inciting bodily harm to a serving public official I will leave your imaginations to construct your own scenario.

  47. Anonymous

    “I have an analogy for what should be done with HIM by Monday morning Tokyo time, but since that might be construed as inciting bodily harm to a serving public official I will leave your imaginations to construct your own scenario.”

    Don’t bother worrying about Cox. He’s abused his position by acting as a rubber stamp for the financial industry, so God will punish him in Hell. However, it is too bad that the system won’t punish Cox’s decisions they way it punished Gonzalez’s. High-profile people from DOJ usually get a job paying over $1M from some law firm, and Gonzalez hasn’t found a job with any big law firm.

  48. Anonymous

    This being nakedcapitalism and all I thought you might enjoy Paul Krugman’s silly pun:

    Someone has to say it

    So why not me? The entire financial sector has just lost its shorts.

  49. Anonymous

    September 20, 2008

    As a newly inducted member of the Crimson Permanent Assurance Pirate Gang (CPAPG) in am required to post this message as part of my initiation:


  50. bg

    Although I just lost a lot of money on my financial shorts, the short ban may have a net positive effect for our country for two reasons:

    1. The government sponsored short squeeze temporarily stopped the death spiral: lower stock price, downgrade, run on the bank, lower stock price. This give regulators more time to recapitalize the financials.

    2. We may discover again why it is a bad idea to make shorting illegal… just like we periodically have to discover why prohibiting alchohol (and drugs) is a bad idea.

  51. Cash Mundy


    Good to have you aboard, me bucko. Too bad about yer house, yer car an yer job, but ye’ll always have a place to swing yer hammock aboard the Crimson Permanent Assurance.

    As for me, I’m all ahoo. Me intellects is set astray by this business of Hank declaring himself a God. Hopefully the Supreme Court will have the whole pack of scrubs walkin’ the plank at swordpoint, but I wouldn’t count on it.

    Well, some make-and-mend day, when yer kit’s all in good order an ye’ve had a tot of grog, so stop by me blog, which not that it’s any good, but since I’ve quoted you at length you could leave a comment and say you’ll sue me or something.

    Which this yere be me blog not that its any good which it ain’t, an more’s the pity.

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