August 31, 2009
It is my understanding that the SEC is contemplating the re-implementation of the uptick rule – or some modified version of the rule that was discontinued in July of 2007.
It is also my understanding that the re-instatement is being pushed by politicians who wish to be populist champions to their constituents.
Re-instating the uptick rule will do nothing to prevent a re-occurrence of the sell-off that occurred in September and October of 2008. As will be pointed out below, the actual reasons for the sell-off were extremely severe - and such a sell off could not have been contained by an uptick rule. In addition, re-instating the uptick rule simply to satisfy politicians who wish to look good to their constituents will set a very troubling precedent.
The SEC is supposed to contemplate regulations that will actually help protect the public, not to simply pacify the politicians or the public. If the public thinks that something may be a good idea, but the SEC KNOWS that it will not be such a good idea, it is the SECs responsibility to use its office to explain to the public why the public is misguided and then offer a more robust option that will actually do more to protect them.
I am concerned that re-implementing this rule will give an incorrect message to the public – which instead could be used as a great opportunity to demonstrate some very important lessons as to how the markets work and what the individual investor should pay attention to and be responsible for. One lesson that must be taught is the lesson of asking questions. Investors who lost money holding certain financial stocks failed to ask certain questions. For example, with so much bad news in this sector, is having my money in this sector the highest and best use of my money? – or – at what point do I say I have to leave this investment?
These are questions that the investor or their advisors should ALWAYS ponder. There will, at some point, be another crisis. It will be sound answers to THESE questions that make investors more prudent and better able to help themselves. Not an uptick rule.
As both the market and the economy work to recover from the 2008 crisis, it seems that the actual losses created by the top financial firms in 2008 have faded from this current debate re: the uptick rule.
The following figures are the cumulative earnings that were released in 2008 --- PRIOR to the Sept. 2008 sell off:
AIG: Announced approx. $23 billion in losses prior to the Sept. 2008 sell-off.
Citigroup: Announced approx. $18 billion in losses prior to the Sept. 2008 sell-off.
Fannie Mae: Announced approx. $9 billion in losses prior to the Sept. 2008 sell-off.
Freddie Mac: Announced approx. $3.5 billion in losses prior to the Sept. 2008 sell-off.
Lehman: Announced approx. $7 billion in losses prior to the Sept. 2008 sell-off.
Merrill Lynch: Announced approx. $15 billion in losses prior to the Sept. 2008 sell-off.
Wachovia: Announced approx. $9 billion in losses prior to the Sept. 2008 sell-off.
WAMU: Announced approx. $6 billion in losses prior to the Sept. 2008 sell-off.
A total of $90 billion in losses were announced by just these EIGHT firms over the course of the first seven or eight months of 2008.
When some of the top firms in the U.S. financial sector are averaging losses of over $10 billion each (in just over a half of a year) - the market is going to go down hard and fast. It is sad to think that some general uptick rule is being considered by the SEC to prevent or control the next crisis – particularly if it is a crisis involving the financial sector.
When the U.S. financial sector is operating this poorly – the market is going to go down hard and fast. Given that the market looks forward - when there is talk that things will get much worse (like AIGs next announcement of losing approx. $62 billion, Fannie Maes next announcement of a $25 billion loss, Freddie Macs $24 billion loss, Wachovias $24 billion loss, Merrill Lynchs $10 billion loss ) – the market is not going to go down slowly.
Investors need to learn that when the management team running the firm they have invested in makes huge mistakes, the market will mark these firms down very quickly. Just as it did Enron in 2001 – which happened WITH THE UPTICK RULE BEING IN EFFECT. Enron basically disappeared in a matter of months, WITH THE UPTICK RULE BEING IN EFFECT.
In 2008, the eight firms mentioned above released earnings reflecting losses of more than a billion dollars 19 different times.
Isnt it possible that it was the constant drum beat of extremely bad news in this sector that initiated very aggressive long liquidation (as opposed to so-called predatory shorting), and that this aggressive long liquidation was actually the dominant factor in the rapid price declines in the financial sector seen during the August 2008 to October 2008 time period?
These firms made decisions that resulted in them becoming flawed firms. An uptick rule would not have solved their problems anymore than the (then active) uptick rule helped to solve the problems of Enron and WorldCom. Both went to zero, despite the uptick rule being in effect at the time.
Re-instating the uptick rule may give the public the impression that the 2008 crisis came out of nowhere and that it could happen to any firm at any time. This is not true. Wal Mart, McDonalds, Exxon Mobil were all profitable during this period. Apple Computer was clearly targeted by short sellers upon the release of Steve Jobs health issues. But the company was both profitable and met or exceeded analysts expectations during this period. Apple Computer actually went HIGHER during the absence of Jobs, despite the aggressive shorting. Investors did have other alternatives during the crisis. Wal Mart, for example, actually finished 2008 with a gain – year on year. Again, prompting investors to ask the question - what is the highest and best use of my money? is a great lesson that can come out of this unfortunate crisis. As opposed to saying - dont worry – the uptick rule will save you.
If the SEC wishes to protect the public, it should send a signal that a key point of focus needs to be on how these firms got into so much trouble in the first place. Particularly since non-financial firms depend mightily on the financial firms for their own fiscal well being.
The SEC will not be protecting the public by attempting to mask a severe systemic risk problem with Saran Wrap type uptick rules. By not re-instating the uptick rule the SEC would send a signal to investors that the investors should focus on distinguishing well run companies from flawed companies. As opposed to hoping that the SEC will create some rule that will protect whatever it is the public decides to hold (only to be disappointed when the next crisis comes and the stocks are hit with large losses anyway - despite the "uptick rule").
Instead of a toothless, cosmetic and potentially misleading uptick rule, the SEC should seriously consider setting up a liaison policy with the Federal Reserve and/or the Treasury Department. This liaison policy could detail how the agencies will work together when some sort of systemic risk – particularly to the financial sector - appears.
In the event of pending systemic risk, the agencies would work together to determine the SPECIFIC and TARGETED action(s) that need to be taken. For example, perhaps placing a temporary ban on short selling until the systemic risk is dealt with. This ban could be for the troubled sector in question or in extreme cases – the entire market. Other targeted actions could be possibly halting a stock or a group of stocks if there is evidence of some sort of predatory activity.
This approach would not interfere with the day to day operations of traders / investors who decide to short sell because they feel a security is over-priced, an activity that is necessary and may help to counter or temper price bubbles. Yet, such an arrangement will still allow the SEC and other regulators to effectively address systemic risk issues.
Last, since the uptick rule will not really help support market prices in the event of a systemic risk sell off – this type of coordination with the Federal Reserve and/or Treasury Department is something that the SEC would end up doing on an emergency basis anyway. So just make it policy. Please contemplate meaningful policy vs. some sort of cosmetic make believe pacification.
As an active independent trader, I can definitely say that the changes made over the last year to the rules overseeing the borrowing of securities for short selling have worked to curtail short selling. There have been several occasions where my clearinghouse (which is one of the largest in the business) told me that they could not locate shares in the security I wished to short sell.
In conclusion, the SEC should explain to the public (and to the politicians) that the SEC has already taken steps to eliminate predatory shorting by tightening up the security lending and borrowing process. It should be explained that securities that were very easy to short a year ago are not easily shortable today.
The SEC must also make the case that the next crisis is likely to be very different from the last crisis and that the best solution for the next crisis will require specific, targeted action – action that will not be satisfied by a general cosmetic uptick rule. It should be announced that the SEC is working with the Federal Reserve and/or Treasury to set up a joint quick response team to address the markets exposure to future systemic risk, and that this team will have the power to take additional action regarding short selling if necessary.