Short-selling bullies aren't to blame
Yes, bringing back the uptick rule is probably a good idea, but it's silly to think it will solve the banking sector's woes. Shorts aren't the biggest problem.
 |
| The SEC got rid of the uptick rule in July, 2007 and markets peaked shortly afterward. Would bringing the rule back end the pain? |
NEW YORK (CNNMoney.com) -- This is a strange little rally. Stocks surged Tuesday and continued to head higher Wednesday morning.
Most are attributing the big move to a couple of factors. Federal Reserve chairman Ben Bernanke appeared to support modifications to the controversial mark-to-market accounting rule, a rule that requires companies to report the value of assets at current market prices.
There was also a memo from Citigroup CEO Vikram Pandit to employees that came to light Tuesday in which he said the troubled bank was actually profitable in January and February.
Finally, there were reports that the Securities and Exchange Commission may soon consider reinstituting the uptick rule, which prohibits short sellers from shorting a stock while it's falling.
Any changes to mark-to-market accounting would probably be viewed as a plus, at least in the short-term, since many experts think that this rule is a major reason why banks, many of which are stuck with assets that are nearly worthless today, have been posting such huge losses lately.
As for Citi (C, Fortune 500) ending its five-quarter run of losses, we'll soon find out if earnings and Citi belong in the same sentence or if profits at the bank are as mythical as the Easter Bunny.
Citi is scheduled to release first-quarter results on April 17 and analysts are still forecasting a net loss of about $2 billion, or 32 cents a share, according to Thomson Reuters. No analyst is predicting a profit. So someone's gonna be wrong in a big way.
But it goes without saying that if Pandit isn't pulling the market's leg, a return to profitability for the semi-nationalized bank is great news for the financial sector, broader markets and taxpayers.
However, I'm not 100% sure that the SEC's renewed crusade on short sellers, which it began last fall when bank stocks first began to plummet, is necessarily a cause for euphoria and elation.
Don't get me wrong. Bringing back the uptick rule is a big step in the right direction.
The SEC eliminated it in 2007 and some have argued that doing so made it easier for short sellers, who borrow a stock and sell it with the hopes of later returning the shares after buying them back at a lower price, to wreak havoc on the markets.
I think that, to a certain extent, this is true. That's why I wrote the following in a column in October: "The uptick rule was first adopted in 1938 to prevent bear raids...exactly what the SEC is trying to stop from happening now. Why not bring back the uptick rule?"
Harlan Platt, a professor of finance with Northeastern University in Boston, said that bringing back the uptick rule could stabilize some financial stocks because it does appear that some hedge funds are ganging up on banks. He compared to it a schoolyard bully beating up on the weakest kid on the playground.
And this, Platt added, is a big problem since stock price declines at financial firms have a bigger impact on their core business than at say, a technology or industrial firm.
Still, if you think that the markets are now free and clear to head higher again just because the SEC is going to make it harder for shorts to make money, then, in the immortal words of British heavy metal band Judas Priest, you've got another thing coming.
"There is no evidence that short sellers have been bringing this market down," said Eric Newman, a manager with the TFS Market Neutral fund, which use both long and short-selling strategies. "GM (GM, Fortune 500), AIG (AIG, Fortune 500) and Citi are losing billions of dollars and are probably insolvent. To blame short sellers for that is naive."
To be sure, reinstituting the rule makes a heck of a lot more sense than the SEC's ill-conceived temporary ban on short-selling financial stocks last year. Many big financials continued to sink even though bearish investors were prohibited from shorting them. That's further proof that short selling isn't really the main problem.
"I don't think a change to the uptick rule is a panacea for the market. What we saw when the SEC announced they would suspend short sales of financials was a temporary bounce and then continued weakness," said Paul Baiocchi, senior market strategist with Delta Global Advisors, an investment firm based in Huntington Beach, Calif.
Here's the real issue. There are some short sellers out there who try and manipulate the market. Some unfairly target certain stocks and make matters worse for them by spreading false rumors. If bringing back the uptick rule makes it more difficult for those who are committing fraud to profit, I'm obviously all for that.
But the SEC can't just stop with the easy stuff. It needs to more forcefully go after those who are not playing by the rules.
SEC chairman Mary Schapiro, speaking in front of a House Financial Services subcommittee hearing Wednesday, vowed to crack down more on "combating false rumors and manipulative activity" specifically when it comes to shorts.
But keep in mind that fraud goes both ways. There are also investors out there who talk up the merits of stocks to try and cause a spike and then sell them later, the phenomenon known as the "pump and dump."
So finding the actual crooks, whether they be long or short, is the right solution. Hopefully, the SEC is up to the task. Demonizing the practice of short-selling is not the answer.
"The SEC's job is not to promote the stock market," said Platt. "Their task is to ensure that the market is fair."
Shameless plug alert: Before I started writing The Buzz, I covered the media business for several years at CNNMoney.com. Some of this reporting is the basis of a book I've written about News Corp. CEO Rupert Murdoch called Inside Rupert's Brain, which will be published on March 19 by Portfolio, an imprint of Penguin Group (USA). 
