The SEC Panics

I think it was about the time that the SEC started trying to curtail short selling that I finally decided that we're in panic mode. The market's actually flat, as I write this, although Fannie and Freddie are down 20%, maybe because the Ackman plan actually makes quite a lot of sense.

Ackman's idea is to wipe out the current shareholders, and then create new equity by taking each dollar of senior unsecured debt, and replacing it with 90 cents of new debt and 10 cents of new equity -- a much more sensible leverage ratio than what we've got right now. The government would put a floor under the value of the equity, so the debt holders would retain at least face value, even if they lose some coupon income on the 10% of their debt which becomes equity. If I were the US government I'd go a little bit further and guarantee the next three years' coupons too, maybe give existing shareholders a small stake as well, but that's really a niggle.

In any event, the SEC response was to ban naked shorting of Fannie and Freddie. You can still buy puts, load up on protection, borrow stock and sell it, all that kind of thing; you just can't sell stock you haven't borrowed.

The most charitable view of this is that the move is political, designed to make it seem like the SEC is Doing Something in the face of all the chaos. But it doesn't look like that: it looks like the SEC is happy signing on to the belief that stocks wouldn't be falling if it weren't for short-sellers. In other words, the Powers That Be don't trust the market, and the SEC has gone from facilitating price discovery to making it harder.

Meanwhile, check out the RBS share price: down another 10% today, to seriously distressed territory:

The stock is now yielding close to 12 per cent and sits on a discount of 40 per cent to forecast book value.

You think that's all the fault of short-sellers too? I don't. I think that financials in general are toxic right now, and that the market has to get its revulsion for them out of its system. I think people who bought at 2x an overstated book value should finally give up and sell at 0.5x the new, lower, book value, and I think they should be proved smart as a couple more big retail banks get taken over by the FDIC and their equity goes all the way to zero. And then I think people should realize that the sun is still rising in the mornings, that good borrowers like InBev can still line up $45 billion in financing, that people can still buy houses if they're able to put 10% down, and generally that the financial system still works fine. It might not be hugely profitable for shareholders, but it's still capable of driving the economy.

So let the short-sellers do their worst. It'll just hasten the necessary and inevitable, and that's probably a good thing.