The SEC’s Bold Step Into The Markets Mandates Quick Follow Up Measures
Last week, the SEC took extraordinary action with a package of measures discussed here which injected the agency into the trading markets in an unprecedented manner. By temporarily banning short sales in the shares of selected financial institutions – presumably those thought to have large portfolios with toxic mortgage related assets – the Commission halted part of the downward pressure on the shares of those institutions. Effectively, the Commission acted as a circuit breaker to halt what many thought might be severe downward pressure on the share price of financial institutions which could lead to further dislocation in the markets. The actions were taken in conjunction with Federal Reserve and Treasury, who, along with Congress, are now racing to create a bail out of these institutions and stem further collapse and turmoil in the markets.
While nobody wants to see further market turmoil or the collapse of addition institutions, many have questioned, if not protested the Commission’s emergency actions. Many claim that the shorts have been unfairly targeted without any proof that their trading has been improper or manipulative. Others argue that the SEC’s actions are inappropriately propping up the shares of the 799 financial institutions whose shares can no longer be traded short. Still others contend that at best, the up-tick rule, long a mechanism thought to prevent causing so-called “bear raids” with short trading, should be reinstated. And, still others claim that it is unfair to change the rules of the game in the middle.
No doubt all of the Commission’s critics make valid points. At the same time, each of the critics misses the point. The actions by the Commission are temporary, limited and tailored to the situation at hand. At the moment, there is tremendous uncertainty in the markets and with good reason. These are extraordinary times. Many financial institutions hold millions and in some cases billions of dollars in toxic mortgage related assets on their books. At the same time, there is a lack of sold factual information about the true value of these assets today and in the future. Many of those assets today may not have much value if measured in terms of what a willing buyer would pay. At the same time, long term, those assets may have significant value. Today, however, nobody knows. The markets hate uncertainty. Trading is being driven in many instances by rumors and speculation. While that is frequently the case, in these extraordinary times the impact can be very dramatic and multiplied many times beyond what would be typical because of the conditions.
In today’s market, the share price of a financial institution can easily be driven into a “death spiral” starting with rumors causing traders to bail out, followed by more bailing out, added to by computer programs that get tripped and all added to by traders assessing the trend who start selling short. Very quickly, the share price plummets to near zero causing an already shaky institution to crumble. That sends even more shock waves through the market. This is not the kind of bear raid that many believe caused Bear Stearns to collapse. It is just a rumor-driven spiral to collapse.
Regardless of the cause of a death spiral, when the share price free falls to zero, not because it reflects the inherent value of the company – and markets are about price discovery – the loser is not just the institution or Wall Street, but also Main Street. Thousands of small investors across the country hold shares of these financial institutions either directly in their retirement accounts or through mutual funds. When these institutions crash, it is those shareholders who are the real losers. It is those small shareholders who have worked hard for years to build their retirement accounts and are counting on it for their future that are wiped out and left with nothing. And, it is thousands of people at those institutions who lose not just their jobs and much of their savings which is frequently tied up in the stock of their company. The SEC’s step into the markets last week protects all of these interests.
At the same time, there is little doubt that the SEC’s extraordinary market intervention is interfering with the normal operations of the market and that its critics make have valid concerns. For this reason, it is imperative that the Commission’s circuit breaker action be brief.
The SEC made it clear in instituting its market measures that it was expanding its enforcement investigations and taking other actions to examine trading in the markets. It is imperative that the SEC and its enforcement division move quickly in conducting these inquiries. At the same time it is important the Commission and its investigators look for more than evidence of the typical “bear raid.” Investigators must carefully consider what is driving the kind of trading which might cause the share price to spiral down and which necessitated the Commission’s step into the markets. It may be that much of this action stems from rumors and speculation that are driven by a lack of hard market information about the true financial condition of the 799 financial institutions covered by the short sale orders. It may be that what is needed is not an enforcement action against a few manipulators, but new and better disclosure rules and provisions. If so, the Commission should be prepared to act quickly with either new rules or proposals for legislation.
The extraordinary acts taken last week are a circuit breaker, not a long term fix. By stepping into the market, the SEC took a bold step to stabilize the current situation. Now it must quickly follow up and stay in lock step with the Federal Reserve, Treasury and Congress to restore market confidence and the traditional trading rules.