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All Up, No Down

The ban on short-selling financial stocks is worthy of the worst dictators...

worth his salt will tell you, the simplest way to avoid criticism is to make it illegal, writes Joel Bowman for The Rude Awakening.

   Last week, in a characteristically misguided effort to "do something" about the current turmoil in the financial markets, the government did just that. Posing for the news cameras of the world, the Securities and Exchange Commission's chairman, Christopher Cox, announced that the practice of selling short financial institutions is now banned.

Just to be clear, this draconian ruling pertains not only to naked short selling – where traders sell short a company without first acquiring stock in it – but to ALL short selling.

We'll say that again: to sell short any one of 799 financial companies identified by the SEC is now to engage in an illegal activity. We half expected this announcement to be followed by the line "Dissidents will be shot on sight."

Short selling, if we are to believe what the financial Gestapo tells us, is responsible for the ongoing tumult in the markets – not the flagrant destruction of shareholder wealth by miserly CEOs; not their greed-infused appetite for risky mortgage-backed securities; and certainly not the delusional reticence of these suits to admit they made mistakes and to take their medicine alongside those whose money they squandered.

Such exercises in government-sponsored deceit should come as no surprise to even the most casual students of history. Deceit is, after all, as old as the trust it betrays. From Eve's apple to the "proverbs" of Chairman Mao's Little Red Book, we humans have a long and embarrassing history of being duped.

Whether in the realm of finance or politics, the ingredients required to achieve a functioning dictatorship are commonly held. They include, in no particular order:

  1. A healthy disdain for free thought and its expression;
  2. A team of henchmen to execute your oppressive orders (and those found to be flouting them);
  3. A scapegoat to take the fall when your policies collapse under the weight of their own idiocy; and (this final one is arguably the most important...)
  4. A populace too fearful or ignorant to do anything about it.

But perhaps the dictators have their guns pointed at the wrong target. The punishments the market dealt out to the perpetrators of such fiscal madness are rarely without reason.

Had Jim Chanos not blown the whistle on Enron's foray into the grubby world of book cooking, for example, who knows how long their criminal activities might have lasted, or how many shareholder dollars might have been burned in the process.

Victimizing those who bring to light these actions does not diminish their inherent criminality. At best it merely delays the inevitably implosion of the institution in question; at worst, it allows for an environment where unchecked lawlessness become commonplace.

As Jonathan Weil astutely observed in an excellent column for Bloomberg recently, "Mr. Market doesn't believe any major US bank's balance sheet, partly because the SEC has done all it can to buy them time.

"For the first time in 13 years, a money-market fund broke the buck. U.S. taxpayers just bought 80% of AIG for $85 billion, marking the nation's official coming-out party as a socialist state, only with fewer social-welfare benefits for the bottom 99%.

"More bailouts are a near certainty," Weil continued, "after the Federal Reserve and Treasury crossed the line in the sand they drew just three days ago when they let Lehman fail. Nobody knows what the criteria for a bailout are, only that Fed chief Ben Bernanke and Treasury's Hank Paulson might know it when they see it."

If we are to believe what Christopher & Co. tell us, guys like Chuck Prince and Stan O'Neal and Dick Fuld are not to blame for engaging in company-destroying speculations. It's the messengers who told us about it that deserve to be punished.

May we not forget that it was this same warped logic that got us into such a precarious position in the first instance. One may be inclined to feel that it was shameless disrespect for shareholders, criminal deceit and back ally collusion with ratings agencies that are to blame...not the short sellers that alert investors to them in the first place.

"The commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets," Christopher Cox said Friday. Apparently Mr. Cox was oblivious to the irony of his statement.

The SEC has no problem with market manipulation, in other words, provided it is they who are doing the manipulating.

"The emergency order temporarily banning short selling of financial stocks will restore equilibrium to markets," continued Cox. We wonder what sort of equilibrium can come from an up without a down? What mutant form of "equal" comes from allowing only one side of the equation?

But far from inspiring fear and trepidation in the hearts of free market enthusiasts, this outlandish step by the financial Gestapo resulted in a 410-point Dow rally. Rather than running for the hills, investors took Friday's shameless intervention as their cue to don their rally caps.

Call us cynical, but we feel very uneasy when politicians get the urge to "do something" concerning the business of Mr. Market.

Personally, we like it better when politicians are locked in battle amongst themselves. At least then they are less likely to "do something". In fact, we'd feel most inclined to vote for the politician who ran with the slogan, "Vote Joe Blogs – We Promise to Do Nothing."

Alas, abstinence is not in the nature of the beast.

Banning short selling may have delayed the inevitable force of market gravity, but it does not make bad debt good. Whether that debt is owned by moribund financial institutions or by the US government, one day it will have to be repaid.

Until that day comes, proceed with caution.

Eric J.Fry has been a specialist in international equities since the early 1980s. A professional portfolio manager for more than 10 years, he wrote the first comprehensive guide to American Depositary Receipts, International Investing with ADRs. Today he reports on Wall Street from California for the renowned Daily Reckoning email service.

See full archive of Eric Fry articles

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