EconInvestor

By Monday, the Securities and Exchange Commission (SEC) will probably modify its ban on short-selling stocks ( SEC bans short selling in hundreds of financial stocks ) to allow options market makers to engage in short selling. ( SEC Considers Revising Shorting Ban in Options Market ) However, the fact that it didn’t consider the effects on the options market ( Options Clearing Corporation Statement Regarding SEC Short Sale Ban) shows how little thought went into the ban.

The ban is a bad idea from two perspectives: short-term and long-term.  For now I’ll assume that the SEC will revise the ban in the options market and won’t go into that issue. 

From a short-term perspective, what happens to those already holding short positions?  It appears that the government just forced them to buy in order to close out their position.  How much of Friday’s run-up was due to shorts closing out?  Why should they be forced to take a loss?  Shorts were engaged in legitimate trading.  The government just changed the rules in midstream.

Rven if the shorts are allowed to hold their positions, the ban on new shorts will put enough short-term pressure to force a close-out at a loss.

Another related short-term issue is the effects on hedge funds. Some of these funds may have to close out their positions at a loss. This could drive down their prices. This could cause a run on the fund or cause problems with their collateral or capitialization.

One long-term issue is that it now increases uncertainty and volatility into the market.  Now traders have to worry about what unexpected action the government might make.

Another long-term issue is that it encourages the idea that the government can step in at the spur of the moment and change the rules of the game.  Another way to make money is to have the government issue a new trading rule in your favor. Already some companies are trying to get on the list of banned from being short sold ( Companies try to scramble aboard SEC short selling lifeboat).

Along these lines, why is  AHD - ATLAS PIPELNE HLDINGS and  NSH - NuStar GP Holdings on the list?  Two oil pipeline companies on a list to help financial companies in distress?  This seems like some insider connection at work.

My next post will go more into this ban.

The Wall Street Journal has an excellent article that follows the events that led to the Fed bailout of AIG. (  Bad Bets and Cash Crunch Pushed Ailing AIG to Brink ) What is surprising is how AIG kept underestimating the amount needed to keep solvent. First it was $20 billion, then $40 billion, then $60 billion, then $70 billion, then $80 billion.  How can management put together a deal when it doesn’t know its financial position?  The answer is: it can’t.

It is clear now why Hank Greenberg’s attempt at a bridge loan failed.  The numbers were probably much bigger than what he was initially told.

I’m still trying to digest the Fed’s move on AIG. One interesting article is  AIG’s businesses for sale as bailout buys insurer time . In the comment section, someone pulled from Bloomberg, the following:

“Greenberg, who remains one of the company’s biggest stakeholders, said the company needed a bridge loan instead of a plan that put the company under government control. An investor group led by Greenberg said in a federal filing hours before the rescue was announced it might want to buy the company or some units or make loans to AIG.”

“`Why would you want to wipe out shareholders when you just need a bridge loan?” Greenberg, 83, said in an interview before the announcement. `It doesn’t make any sense.’ Greenberg declined to comment after the Fed announcement, spokesman Glen Rochkind said. ”

It is easy to second-guess, but it does make one wonder if a non-government bridge loan could have been made instead of the government loan.

Bank of America is buying Merrill Lynch.  ( Bank of America Reaches Deal for Merrill ) According to the Wall Street Journal article, Morgan Stanley and Goldman Sachs are next in the line of shaky financial institutions. 

Merrill is to be sold at about 2/3 of its value a year ago. What a loss to shareholders.

Is there any doubt that we are now in a banking crisis?

Bear Stearns, Fannie Mae, Freddie Mac, now Lehman Brothers. ( Financial hurricane victim Lehman waited too long ) The talk is that there will be no bailout of Lehman…. However, the Fed is already making loans with riskier assets as collateral. If Lehman goes under and the assets are a bust, who is left holding the bag?

One problem in putting Lehman up for sale is how to value its assets. The accounting on mortgage backed securities is a scandal.  Another problem is the real estate holdings.  In the short-term they will drag down the buyer unless they are heavily discounted.

Once again the US Treasury and Federal Reserve will be left with a dilemma. If Lehman is not handled right, the US financial markets could implode.  To prevent this from happening, they may take on some of Lehmman’s problem securities. However, if that happens, there could be a political firestorm.  In any case, the US taxpayer will pay for the bungling corporate management of Lehman.