Back on September 29, Arturo Bris had a great piece in the Wall Street Journal on the counterproductive effects of the SEC’s ban on short-selling financial stocks. As readers of this blog know full well, I have been pounding on the fact that the ban will actually make prices more volatile (here’s an example from back in August).
The benefit of Bris’ analysis is that he actually looked at statistical tests and found that volatility went up, etc. after the ban. This is just textbook stuff. Thanks Paulson for proving that freedom works! Maybe you and Bush are really doing all this as a lesson to glorify the Invisible Hand. An excerpt:
What follows is a snapshot of the landscape before the SEC took action, and then the subsequent findings from my study of the 799 stocks initially covered in the ban. First, the “before” trends:
- Short selling activity was not excessively high for the 799 stocks from January to the ban’s start. While the percentage of short sales to total shares outstanding hit 19.1% in March, that percentage fell to 14.8% in July, when the sector’s stock prices experienced the greatest drops since March 2007. From Sept. 1 to Sept. 12, short sales in the 799 stocks amounted to a low 6% of shares outstanding. Short sales in relation to trading volume display the same pattern.
- Short-selling activity typically picked up after a stock fell in price, not generally before. Increases in short selling of individual stocks more often occurred the day after a sharp price drop, not before. This is consistent with research conducted by Karl Diether and Ingrid Werner of Ohio State University, and Kuan-Hui Lee of Rutgers, showing that short sellers trade in response to past negative news, and that they reveal information about forthcoming price drops. They may also want to protect their long positions from further declines by locking in prices through short sales.
After the ban took effect last week, we saw a dramatic shift for the worse (market quality and stock liquidity declined) as investors found it increasingly difficult to hedge market risks.
- Liquidity dried up. With lenders halting their stock loans, volume down and regulatory uncertainty high, less capital flowed into trading of the 799 stocks. Bid-ask spreads increased more for the 799 stocks than for the market overall.
The intra-day trading range has almost doubled for the 799 stocks over the past week. This means that liquidity deteriorated. Less liquidity makes it more difficult for investors to trade without a severe market impact, and prices are less transparent.
- Stocks reacted sluggishly to news. The 799 shares reacted more slowly to news than stocks outside the ban’s umbrella — a key sign of market inefficiency. In an efficient market, individual stocks should be affected primarily by company-specific news rather than overall market activity.
Taken in full, the preliminary findings run counter to the SEC’s stated rational for imposing the ban.
Yes, I invented the title but no, it is not a palindrome.
As usual, I wrote on a topic for different outlets, stressing different themes depending on the audience. EconLib is for super econ geeks, so I get fairly technical (at least by Internet standards) in this piece on the recent financial coup. For example:
Continuing the above logic, there are other firms that might use shorting as a hedge, rather than as a speculative move. In the extreme, suppose that an analyst is dead certain that Medium Bank XYZ behaved beautifully throughout the housing bubble, that there is not a single “toxic” mortgage-backed security on its balance sheet, and, moreover, that XYZ has been very careful to become intertwined only with other financial institutions that have played it safe. The analyst is convinced that Medium Bank XYZ is one of the safest banks out there.
Even so, it does not follow that the analyst will recommend buying large numbers of shares in XYZ. After all, it is a minor player, and if bad news about a regulatory change or some other event sweeps the market, then XYZ’s stock might go down with the herd. A much safer bet, therefore, would be the spread between XYZ and comparable financial stocks. For example, the analyst might recommend that clients take out a large long position on XYZ, while taking out much smaller short positions on the largest five banks. The SEC’s ban has now made this hedge illegal, and thus our hypothetical analyst may now recommend less aggressive buying of XYZ.
So argues Naomi Wolf (not to be confused with Naomi Klein, author of The Shock Doctrine). Now folks, Robert Wenzel sent me this 27 minute YouTube, and I wrote back, “What part should I listen to? I don’t have time for this whole thing.” And he just said, “The whole thing, man.”
He was right.
You’re busy, I know. Fair enough. Just start running it and then go check your Bloglines, your fantasy football team, whatever. Wolf sounds very credible and what she is saying is very scary. She ties together a bunch of things that I have been harping on here at Free Advice, but she connects them in a way that I hadn’t done. By about the 15:00 mark, I think you will agree with her that a coup has taken place.
Incidentally, below is the clip she alludes to, where Brad Sherman (the same guy I gave a wise aleck answer to when I testified before the Financial Services Committee) says that representatives in Congress were told the president would impose martial law if they didn’t vote for the bailout.
I really don’t take pleasure in pointing this out, not the least reason being that I have a (very modest) retirement account in global equities. But we were told we needed to fork over $700 billion to reduce volatility and shore up confidence in the financial system. Well, as of this writing, the Dow is below 10,000, and the S&P is down 4.75% on the day.
Is it too late to have a Do Over?
Here’s a link to a fairly impressive demonstration that might surprise those who thought the offshore ban had nothing to do with current prices. The money chart:
NOTE: In the interests of complete academic honesty, I should note that after I wrote the above article, someone asked me if the price for natural gas looked the same. (After all, offshore drilling will tap into natural gas deposits as well.) The 2nd inflection point is beautiful, but for the first one, the natural gas price peaks more than a week before Bush lifts the executive ban.
This compilation was in the Wall Street Journal on October 2. It sat on my counter for a few days, as I couldn’t work up the effort to actually see just how dumb some of these politicians’ confident statements about the mortgage giants were.
I’ve finally read the compilation, and it’s worth it. My favorite example:
Rep. Frank: Let me ask [George] Gould and [Franklin] Raines on behalf of Freddie Mac and Fannie Mae, do you feel that over the past years you have been substantially under-regulated?
Mr. Raines: No, sir.
Mr. Frank: Mr. Gould?
Mr. Gould: No, sir. . . .
Mr. Frank: OK. Then I am not entirely sure why we are here. . . .
One of the most challenging academic questions for theists is, “Why does God allow bad things to happen?” Unlike other brain teasers involving God, this one really hits home, for obvious reasons.
Now I think part of what is going on–and I am a born-again Christian, so that colors my explanation here–is that God wants us to really really trust that He will forgive us for our sins.
And so, by allowing sinners to do atrocious things but then being willing to forgive them, God encourages onlooking Christians to feel less guilty for the sins they’ve committed, and thus concentrate on loving everyone, as Christ commanded them.
Finally, in this component of the reason, again we find that the Crucifixion was the ultimate example. If Jesus could ask the Father to forgive the very people who were torturing and murdering Him–as they were doing it, not five years later when He is thinking back on the episode–then we really should trust that He is willing to forgive us.
One of the biggest sources of regret I have is that I never met Murray Rothbard. So I acknowledge that in the following observations, somebody from Auburn, AL could easily destroy me by saying, “Bob, I knew Murray Rothbard. He was a friend of mine…”
Annnywho, here’s what led me to understand why Rothbard could sometimes be…well, a real jerk. (I think poor Hayek is still nursing a nosebleed from Murray the Big Bully.)
I try, whenever possible, to criticize Tyler Cowen. This is because he has established unbelievable credibility for himself, and he has done this necessarily by knowing the mainstream material SOOOO thoroughly that no one on their side would have the audacity to dismiss him as an ideologue. This is exactly what Hayek did–they actually gave him the Nobel (Memorial) Prize, for crying out loud, even though he had the testicles to put “Serfdom” in his title. Do you know how “unscientific” that was? C’mon folks, Hayek really put in the time to infiltrate the mainstream, and then dropped a bomb within their worldview, the implications of which rippled out in all directions. That’s why there are so many diverse applications of “Hayekian” thought. He shattered the dominant worldview in which he grew up. Whom else could you want him to attack, than his powerful contemporaries–which he did?
Anyway, Cowen is like the Hayek of our days. And so if I’m going follow WWRD, I need to go after Cowen and be a jerk about it. See?
Now, there is no denying that Rothbard was bigger than I am. And partly why, is because he put on a better show. If you’re watching Spiderman in the theaters, you don’t hope that Peter Parker can use his wits to avoid all need for violence. No, you want him to go pick some fights with super villains, and then save the day! Go Murray!
So for all of you who lament at how that brilliant Murray Rothbard wasted his opportunity to really shake up the academic world… For good or ill, Rothbard consciously knew what he was doing, just like Ann Coulter is obviously shrewd and has decided she is willing to act like that for money and fame.
Well, in the same way Rothbard was fighting a war against the State, and he decided he would rather fight with the backing of a large number of independent, gun toting, Union hating tough guys, rather than a bunch of academics who might fax letters of support if Rothbard got imprisoned. Yay, thanks professors for getting my back!
So just as I can think Sam Adams was a riot for stealing private property and dumping it in the Boston harbor, I can think Murray Rothbard was a riot for picking such fights with other academics. They must have been utterly flabbergasted at this clearly very sharp guy who was acting like a, a, a, brawler for crying out loud!