July 24, 2008
Selling America Short
Imagine a world in which anyone can buy any amount of fire insurance on any building, regardless of its value or ownership. Imagine that anyone can buy any amount of life insurance on any unrelated individual, without their knowledge or consent.
The economic incentives in such a world guarantee that many buildings will burn, and many will die, to the financial benefit of those buying the insurance policies where they have no risk of actual loss.
Wall Street and the SEC have created such a world. Credit default swaps allow a party to reap a financial reward when a company fails. Shorting the ABX index allows a party to reap a financial reward when asset values of certain financial instruments decline in value. Unlimited shorting of stocks, without restraint as price declines, magnifies both the speed and magnitude of the price decline. Purchase of puts sends a stock price lower as the option market makers sell unlimited, unregistered, un-issued shares into the market.
Where the capital markets once functioned as a source of financing for new business ventures, Wall Street and the SEC have turned the capital markets into an unregulated, rigged casino where gambling and asset destruction are the main attractions. Economic incentives now heavily favor the destruction of investment capital, rather than the creation of additional capital.
What can we expect to be the logical result of the past 8 years of SEC and Wall Street corruption of our capital markets?