On Tuesday, July 15th, the SEC made the unprecedented move of limiting short selling in certain stocks in the financial sector. Viewing the financial sector as already weakened, the SEC made the radical move to prevent further weakness to many beleaguered companies in the sector, most notably, FNMA and FHMLC, amongst others. The past week has seen massive selling in the stocks of the two GSEs (government sponsored enterprises) and brokerage firm Lehman Brothers. In an ironic twist, it should be noted that the two GSEs stock declines picked up intensity on a Lehman Brothers analyst's research report, that received much media attention over the July 4th weekend, regarding the two companies weak capital positions exacerbated by a FASB accounting rule change (which, again ironically, the analyst conceded would not even apply to the two GSEs).
Short selling is the act of selling a stock that is not owned but borrowed and then sold. The action the SEC is limiting is the act of "naked" short selling, that is, selling stock that is not owned while no attempt is made to borrower the stock. In short selling, money is made by selling at a higher price and buying the stock back at a lower price, the difference being the profit. The SEC is limiting naked short selling for the next 30 days, starting Monday, July 21st.
Because FNMA and FHMLC play such a significant role in the housing industry and are critical in the sector's recovery, the Federal government has been active in trying to shore up confidence in the two GSEs. Their declining stock values and eroding investor confidence make it harder for each to raise capital, and this week Moody's Ratings Agency downgraded the preferred stock and bank rating of each. One trader referred to the stock declines as "thermonuclear". The following url links to a Fortune magazine article on Moody's downgrade.
http://dailybriefing.blogs.fortune.cnn.com/2008/07/15/moodys-casts-jaundiced-eye-on-fannie-freddie/?source=yahoo_quote
Although the SEC's move seems dramatic and radical, it is believed that such a move will have little impact on curbing the short selling in the market place and will do little more than make it mildly more expensive for short sellers to operate. Many argue that short sellers are a necessary part of a healthy market as the action alerts the market to overpriced securities and naturally deflates inflating bubbles.
I think the US Government has stood by long enough and cannot afford to let the market dictate the fate of the two GSEs. I have never believed in a purely capitalistic model, and the Governments role, however limited, must exist as a safeguard in unusual circumstances, and these circumstances continue to become more and more unusual.
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