SEC Sells Economy Short

SEC Chairman Christopher Cox’s emergency announcement that the Securities and Exchange Commission will limit short sales of stocks in Fannie Mae, Freddie Mac, and brokerage firms for 30 days is yet another step in the government’s interference in the workings of the economy. It’s a desperate move that will have no long-term effect in stabilizing the markets.Mr. Cox’s action follows on the announcement made earlier this week of the federal guarantees of Fannie Mae and Freddie Mac, the bailout of Bear Stearns, and the opening of the Federal Reserve’s discount window to investment banks, as well as to Fannie and Freddie.Mr. Cox will require short sellers of the listed securities to own or borrow the securities before they sell them short, and then deliver the securities on the settlement date. In “naked short-selling,” people generally sell a security they do not have in the hope of buying it later at a lower price. This would now be prohibited unless they own or borrow the security that they sell.In the professional market short-selling is not considered riskier or more unusual than going “long,” buying something and owning it in the hope of selling it later at a higher price. If traders think the price is going up they go long: if they think the price is going down they go short.Both activities are vital parts of the market. If speculators didn’t go long there would be nothing to support the price of undervalued stocks. If speculators didn’t go short there would be nothing to control market bubbles and force down the price of stocks that were overvalued.There are different ways of “going short.” People can’t normally sell something they don’t own because they wouldn’t be able to settle the bargain. Market professionals will borrow stock to fill their shorts; they go to an asset manager who holds the stock and wants to earn fees for his clients — pension plans or investors — and pay him a fee to borrow the securities. Professionals can then deliver the borrowed security to complete their sale. When they “close out” their short by buying the security back, they return it to the stock lender.Day traders and private individuals who don’t have the credit standing to borrow stock may go short without borrowing, betting that they can buy in the stock before they need to deliver it. These are the individuals affected by the SEC rules. But they are an insignificant part of the market: major players in the banking and hedge fund communities go short either by borrowing in stock or via the derivative markets.Mr. Cox’s action will have no effect on professional traders because they already borrow securities before selling them short. So, why did Mr. Cox make this announcement?Perhaps Mr. Cox is trying to stop traders from driving down prices with false rumors. But large traders won’t be affected. Besides, it’s already illegal to spread false rumors, and those who do can be prosecuted under existing laws.It’s possible that Mr. Cox is trying to stop small investors and day traders from panicking. By announcing curbs in short selling, individual consumers, whether they sell short or not, might conclude that the SEC is “doing something,” and so their confidence in the economy might get an upward boost.Most likely, Mr. Cox and the administration are scared because they have effectively nationalized a large slice of American finance without congressional debate or discussion by the American public.Here’s how the financial sector has been nationalized. Earlier this week the Treasury guaranteed the loans of Fannie Mae and Freddie Mac. Last March the Fed allowed primary dealers of the Federal Reserve Bank of New York, including major investment banks, to borrow directly from the central bank, as ordinary banks are already allowed to do.The Fed and the Treasury have made hundreds of billions of dollars of credit available to allow almost unlimited borrowing by the financial sector. This makes the Fed the lender of last resort, and is practically equivalent to stealth nationalization. No wonder they are panicking.What is extraordinary is that someone like Mr. Cox, who has a reputation of being an advocate of free enterprise and free markets, would stoop to limiting short sales in such a manner. This is the type of action that a regulator would do if he did not know anything about markets — and Mr. Cox is one of the most knowledgeable regulators in government.Short-selling has a valuable function. If prices get too high, short selling brings them down again. We deplore market abuse, but short selling is not market abuse. We should treasure the instruments that our financial markets have created because they have made our economy into the powerhouse that it is today.Ms. Furchtgott-Roth, dfr@hudson.org, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute.

SEC Sells Economy Short

SEC Sells Economy Short

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