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September 21, 2008

How To Still Short Financials

The Security Exchange Commission and its equivalents in several other countries have banned short selling of financial stocks. As a result, financials rallied on Thursday and Friday.

This was an utterly dumb move that will have some bad side effects. The financial stocks did not sink because of short selling, but because those companies are in bad shape and their future profits, if any, will be small.

While the SEC measure will prohibit small investors from profiting on the downturn, big investors have a very easy way around this.

They will simply go short on complete indexes like the Dow Top 30, FTSE 100 or S&P 500 and will then go long, i.e. buy, all single stocks in that index that are not the ones they want to target. The net effect is a short position on the targeted financials only.

It will take a day or two for large hedge funds to set this up effectively and reprogram their computers to automate the process. Then the financial stocks will sink again as is appropriate.

The SEC would have to prohibit all index option trading to prevent this, but that would freeze and ruin lots of investors like pension funds that have done nothing wrong.

To ban shorts on financials was a stupid step, an outright manipulation of the markets and a warning to all. The SEC, Fed and Treasury are quite capable to take more such steps and thereby turn the already bad situation into a even worse one.

Posted by b on September 21, 2008 at 9:45 UTC | Permalink


Recommended: Bill Moyers interviews Kevin Phillips

Posted by: b | Sep 21 2008 9:47 utc | 1

It was obvious that it would take finance wizards not more than 10 minutes to find ways around the short-selling ban. I am sure this is only the first method.

Posted by: Alex | Sep 21 2008 11:02 utc | 2

They will simply go short on complete indexes like the Dow Top 30, FTSE 100 or S&P 500 and will then go long, i.e. buy, all single stocks in that index that are not the ones they want to target.

Judging from the s&P 'fair value',the index market makers are baking the "unshortable" quality of financials into the basis (ie discounting the forwards against the cash components. The whole point is to charge the market more money to short, not to eradicate the practice (technically impossible.) Not because short selling caused the slide, but to remove an incentive for predatory CDS trading that falls outside SEC jurisdiction.

Posted by: vaudois | Sep 21 2008 11:15 utc | 3

& this cost of carry is likely to carry over into all financial stock options, index options, SSFs so there'll be no free lunch... if you'd like to buy puts or do anything with an embedded short financial, whoever warehouses the unhedgeable length will charge for it. eg .... based on MStanley's conversions, it's in backwardation.

Posted by: vaudois | Sep 21 2008 11:27 utc | 4

Great link, thanks, b. Rubinama indeed. Then Paulson. There does seem to be just a slight advantage to those controlling government finances and opposition policies when they come from Goldman Sachs. Maybe even the great bailout has something to do with this. But I doubt it. Surely there is no corruption in Congress.

Posted by: gordon | Sep 21 2008 11:29 utc | 5


The beeb's Robert Peston said something like this the other day:

It's a bit early for definitive judgements about Hank Paulson's plan to rescue Goldman Sachs and Morgan Stanley - sorry I meant the US economy [...]

Surely there is no corruption in Congress...

Posted by: Tantalus | Sep 21 2008 12:36 utc | 6

With share prices driven so high, banks can now raise money by selling their stock. In effect, the government took money from those who were right and gave it to those who have been wrong. I can see no other reason for the ban. Once all the shorts have covered, the stocks will fall harder and faster than before. Mutual fund owners who hold these stocks will see the new prices as well above their true value and take the opportunity to dump their shares at a good price. When the stock is falling, there will be no shorts to cover and slow the descent. Paulson understands all this of course, but all that matters is getting money to the banks.

BTW, Goldman Sachs and Morgan had no qualms about shorting Bear Sterns when it was crumbling.

Posted by: Lysander | Sep 21 2008 15:23 utc | 7

Bernie Sanders' snowball in hell.

On that note, why not also appoint Elliot Spitzer to head the SEC. He's good with numbers and whores.

Posted by: biklett | Sep 21 2008 15:45 utc | 8

He's good with numbers and whores.

Which should be a legal requirement for that position.

Posted by: b | Sep 21 2008 17:59 utc | 9

Damn, you're sharp. Remind me to pack my .38 if we ever play poker... I'll need the edge... no threat intended. Your posts are a breath of fresh air.

Posted by: steb | Sep 23 2008 3:47 utc | 10

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