Tuesday, March 10, 2009

Frank Seeking Redemption?

Is Barney Frank seeking redemption?  Did anyone notice how quiet it has gotten around the SEC since Christopher Cox was removed and Schapiro was instated in his place.  Looks like both congress and the Fed want to restore some order to trading and reverse one of the worst decisions of the decade.

 

To me the uptick rule is more important in today’s style of market trading than it was for the first 50 years of its existence.  That’s because before April of 2001, stocks used to trade in ‘spreads’ or fractions.  Depending on the market and period of time, those fractions were either 1/8ths or 1/16ths (12.5 or 6.25 cents respectively).  So a stock could not price at, say, $10.30, or $20.22 like they can now.  The closest you could come to those prices would be 10.25 or 10.375 and 20.25 or 20.125 on an 1/8ths market.  So you already had some spread control over prices of short sales.  Because of the price spreads, getting your short pressure in on a trade was much harder and took much more patient trading than it does now.  Add in the fact that you had to wait for an uptick to place an order, and you are talking about a large difficulty, as the only way a uptick could occur would be for the price to increase 12.5 or 6.25 cents so that a uptick trade could execute.

 

Today, our markets trade on a point basis of 100, so we can trade in cents.  Now, an uptick occurs at any cent value above the current trading price.  So shorting is much easier.  Take away the uptick rule, and now shorters can add hundreds of thousands of dollars worth of pressure at ANY price tick, up or down!  Meaning that if a short position trader thinks that the price has hit a peak, they can buy in at any price even if the prices are continuing downward.  And then once the stock does fall sharply, as long as it falls past the price of their last buy in price they have made money on all of their positions.  That is something a short trader couldn’t do over a year ago.  So it’s no wonder shorters are adding massive amounts of downward pressure to stocks as they fall.  They can make hoards of money that weren’t possible to make a year ago, and even especially 9 years ago.

 

To me it is no surprise the markets are way off their highs.  The SEC let it happen.  Take a look at a chart from the day that the SEC undid the uptick rule, and the markets have had a hard time trading above the closing value of that day, July 6th 2007.  And volatility has been enormous.

 

I’m glad they are finally revisiting the idea of reinstating the rule.  I think the only reason we did not have a “crash” last year was because in September, shorting bank stocks was completely banned for a few weeks, allowing banks to refinance some much needed cash positions through increased stock sales.  If you consider it, many companies fund expansion through stock sales.  If the stock price continues to be compressed downward due to shorts, companies will find it hard to fund expansion, and will begin to cut back.  Which is what has happened.  Maybe Bear Stearns would have been able to refinance with the help of stock sales to shareholders.  But when the stock declined basically to $0 in a week’s time, that would be impossible, as was proven.  And no wonder it could decline so fast – uptick rules had been removed, so you could continue borrowing stock (shorting) and selling it lower the whole way down.

 

http://www.bloomberg.com/apps/news?pid=20601087&sid=a6pBZZrZtxm4&refer=home

 

Tijs Limburg

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