Washington Should Stop Favoring Short-Sellers

WASHINGTON SHOULD STOP FAVORING SHORT-SELLERS by Rich Karlgaard

Saturday evening in Prescott, Ariz., I walked the town square looking for a meal. One cafe had this sign in the window:

Depression Chili–$2 A Bowl

In normal times, this sign would constitute a clear buy signal. Of stocks, not chili. Advertising slogans are a barometer of the popular mood, so when images of soup lines are used in advertising, it means Great Depression fear has saturated the culture. From an investor standpoint, the fear is oversold.

The opposite mood, giddiness, soaked the culture during the summer of 1929:

Joe Kennedy, a famous rich guy in his day, exited the stock market in timely fashion after a shoeshine boy gave him some stock tips. He figured that when the shoeshine boys have tips, the market is too popular for its own good, a theory also advanced by Bernard Baruch, another vested interest who described the scene before the big Crash:

“Taxi drivers told you what to buy. The shoeshine boy could give you a summary of the day’s financial news as he worked with rag and polish. An old beggar who regularly patrolled the street in front of my office now gave me tips and, I suppose, spent the money I and others gave him in the market. My cook had a brokerage account and followed the ticker closely. Her paper profits were quickly blown away in the gale of 1929.”

For investors, the question is:  Does it still work to bet against the popular mood? I think so, but the worm in this apple is bad public policy. Specifically, the cockeyed policy that has, since late 2007, tilted the investing playing field toward short selling. Good public policy should not side with either longs or shorts. Policy should be neutral.

Bear with me for a paragraph as I tease out this argument.

The fundamental economy is stronger than most people think. What we have is not an economic collapse, but a network blackout. The blackout is not one of electricity or bandwidth, but of prices and credit. If my theory is correct, then once the banking crisis is resolved, confidence will return soon thereafter. Here is the problem: Washington can’t agree on a plan to resolve the banking crisis! The best solution, which won’t cost taxpayers a penny and which will take effect immediately, is to stop these ruinous short raids on banks. How? Three steps:

1. Suspend mark-to-market accounting

2. Make the SEC enforce its own ban against naked shorting.

3. Reinstate the short-uptick rule.

These are not radical suggestions. They would simply return regulation back to where it was from 1938 to 2007 and put shorts and longs on an even playing field.

As I write these words (March 10, 11:45 ET), the S&P is up a whopping 4.7%. Why? Citibank, the poster child for sick banks and the victim of a weeks-long short raid, announced that it operated at a profit for the first two months of 2009.  Imagine that! Citi may not be a picture of health, but it is a hell of a lot livelier than people have gleaned from its stock price.

Why does Washington think it is okay to let short sellers destroy operationally profitable banks?

Back to the original question: Does a sign advertising “Depression Chili–$2 A Bowl” constitute a buy sign? Answer: Yes, but only if Washington policy stops favoring short sellers.