Capitalism is Dead

September 20, 2008

During this week, we saw a 158 year old investment bank file for Ch. 11, another ended it’s 94 years of independence, America’s biggest insurer getting bailed out and entering the federal conservatorship, gold making it’s biggest 1 day move in history, the credit crisis spread outside the financial industry and a huge panic in the short term lending money market fund. And the Dow only ended down 34 points for the week?!?!?

While the headlines above would suggest a shear nightmare-ish bloodbath in the global equities market this week. That was not the case at all thanks to our government. While everyone holding equities in their portfolio or 401k is rejoicing, I should point out that the price we all paid is far too great - capitalism is dead.

Without even getting into the constitutionality of AIG bailout, the SEC decided Thursday evening that they should temporarily ban short selling in 799 financial stocks to “regain” the market’s confidence. The role of short selling has always been a self-correcting mechanism for the free market. Without this self-correcting mechanism, the price of a security (as you can clearly see at the open on Friday) will become very inflated.

While many recent accusations blamed the shorts for the tremulous run on the market (especially in the financial sector), one cannot ignore the fundamentals. It is INSANE to see how much leveraging some of these firms are using. If a firm is going to, in the name of greed, participate in predatory lending practices and lend out money to people who cannot afford to repay it or run their business on this leveraging on steroids model, they (and eventually their shareholders) ought to be the ones paying for it - not the taxpayers. Granted, I have no doubt that manipulative shorting does go on in the market (there was an analogy of someone being able to buy his neighbor’s life insurance policy and then running them over with a car by buying a firm’s CDS and then shorting their stock, creating a nasty spiraling cycle of events) but banning short selling is not the solution.

By banning short selling, the government not only create a window for inflation and mispricing of securities, they also create a build up of short side demand. When this ban is lifted, the market is going to take a kick in the face. And guess what the headlines are going to read that evening?? “Shorts take over the market again.” This is just going to be nasty.

What the government should do instead is to regulate the CDS market better and reimplementing the uptick rule. By providing more transparency in the CDS market taking down manipulative short selling, we can still keep our free capitalistic market. A stock is not guaranteed to appreciate in value, I don’t understand what’s so awful about a long overdue correction.

A “free market” without the self-correcting mechanism of short selling is almost like Christianity without hell.

Posted in News/Events, Trader