Wall Street Distress

The credit crisis is well over a year old and in the past week it has climaxed with Lehman going bankrupt, the government bailing out AIG while assuming an 80% equity interest in the company, and John Thain having the great insight to sell Merrill Lynch at a relatively attractive price to Bank of America. However, these events resulted in credit drying up amongst domestic banks and foreign institutions. The Federal Reserve and its foreign counterparts executed some financial manuevers to ease the stressed markets globally. The U.S. stock markets opened today in a negative direction with much of the focus on Morgan Stanley and Goldman Sachs. Both of their stocks were volatile all day and were subjected to the steepest historical drops in their respective histories as public companies.

As the day progressed, there was a load Roar about the short sellers creating all the problems. The other whisper was about the poor job the SEC has done throughout the credit crises. Rumors swirled about potential government solutions to stem the crisis. Clearly, the government needs to get ahead of the problem as Mr. Bernanke and Mr. Paulson must be getting tired of being firemen.

I am all for a solution. However, late today the UK instituted a policy for the rest of the year that will eliminate short selling of any stocks on the London exchange. I thought that was a dumb idea until tonight when the same idea was being floated by the SEC. Many money managers, individual investors, and hedge funds short stock as a tool for risk management. In fact, many money managers are expected to hedge their portfolios as a fiduciary duty and mandate from the pension funds and endowments who gave them money to manage. The SEC is now panicking because they are going to be blamed for not being proactive throughout the crisis. Short sellers should not be able to sell a stock without borrowing it first and if they spread inaccurate rumors to drive a stock lower, they should be punished. However, the solution is not to prevent short selling of stocks but to reinstitute the uptick rule which will be a simple mechanism to prevent aggressive selling of a stock by the few hedge funds that may be recklessly profiting from the financial crisis.