Wake Me When There's Green

The emergency ban on short selling of financials is over. The ban was certainly foolish and probably ineffective in its goal.

It was foolish because it made the market less liquid and most likely added to volatility. Short sellers are a necessary part of a functioning market. They play an important part in price discovery. In a normal market, when a buyer and seller are combined, an accurate price is reached. When the market is artificially skewed by removing a balancing mechanism like short selling, prices are distorted. In many cases, short sellers are forced to buy in order to cover their short positions. In some cases, short sellers who have to cover their positions are the only buyers.

Short selling is also used as a hedging mechanism. When the rules are changed mid-game, unintended consequences are almost guaranteed. When a position is suddenly unhedged because of a rule change, the entire position can be liquidated or an alternative and less familiar hedging mechanism can be used in haste.

Either way, sudden rule changes make for disorderly markets. The temporary ban on short selling was like locking the doors of a burning building while people were still inside. It clogs the exits and increases panic. Would you announce a sale, lock the doors then keep the customers waiting outside?

If the issue was abusive short selling, there are already laws that make it illegal. Just enforce the laws. If you want to make it more difficult for people to borrow shares before they sell them short, require brokers to have an opt-in program for margin accounts. Shares held in cash accounts cannot be loaned. Make cash accounts the default, and require customers to specifically request a margin account, not the other way around as is currently the norm.

The goal of the ban was to stem to precipitous decline in stock prices of banks. Did it work? As a sector, the financials have plunged 23% in the three weeks since the ban was announced. Another job well done. Golf clap for Chris Cox.

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Today, in the first coordinated rate cut since September 11, 2001, the Federal Reserve, European Central Bank, Bank of England and central banks of Sweden, Canada and Switzerland all lowered rates by 50 basis points.

By the end of the day U.S. Treasury yields rose, a hopeful sign that fear is beginning to abate.