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(originally published by Booz & Company)


A Return, Not to Normal, but to Reality

Jackals and Vampires

S+B: What kind of impact will financial regulation have?
When you look at financial meltdowns, you have to consider the role played by financial jackals, as I call them: short-sellers, unrestrained by oversight of any kind, who pile on and make money when there’s a sign of impending shortages. That’s why Bear Stearns lost $33 billion in value in two days — over a weekend, mind you, when no one was even trading. George Soros did the same thing to Britain in 1992. This year, the breakdown in Greece is another form of the same story. The central bankers of Europe didn’t understand this in the same way that American financiers did, because the U.S. has more experience with jackals.

The shorts have such an effective technique and so much power that the truth, whatever it might be, about real economic value and prospects doesn’t matter. Maybe Greece only needed €25 billion [$34 billion] to avoid default, as was said in February, or €45 billion [$61 billion], as the European Union offered in April. The amount is unimportant. What’s important is, Did you and I and 13 of our closest friends pile on and short this thing? If we did, it’s going down. Foreign exchange rates — the legitimate trading of currencies — is unimportant compared to the pressure brought by shorts.

We saw the great potential danger of this behavior in 1997 during the Asian financial crisis. Those collapses of currency didn’t occur because the countries had suddenly overreached. The jackals were simply picking off the weakest, one by one. We have to fix this problem somehow.

S+B: In other words, regulation of trading is more important than regulation of the banks.
Yes. More precisely, regulation of traders would be a more effective way to regulate the big problems that exist right now in the markets. I hear Wall Street guys say with a straight face — and I think they mean it — that, “Shorts are a part of the natural order. There’s a long, and there’s a short. It’s that simple.” In other words, a short trade is just a deal where you buy an option on a falling price, and they should be allowed to continue.

But I don’t think that’s how the world works. In a short deal as it works in practice, you buy options against the share price, and then you call your friends, and they call all their friends, and then you call the press, and you tell everyone lies about how bad the company is. Then the stock goes down. And that’s not right. It’s an extremely damaging, destructive practice that has no real place in the economy.

The answer would be to either eliminate shorts altogether, which probably won’t happen, or to put back some serious restrictions such as the uptick rule. [The uptick rule, established by the U.S. Securities and Exchange Commission in 1938, restricted the short selling of a stock when its price falls. This rule was removed in 2007.]

S+B: Realistically, though, how much regulation of short selling will happen? The SEC has been publicly considering a reinstatement of the uptick rule since April 2009.
Sure. Don’t push it. “It takes time to do these things.” Seriously, it’s hard to believe that we’re having a debate about whether to regulate some forms of trading. After seeing the collapse of the global economy, and having come close to the edge of destruction for all that we know and hold dear, some legislators are still arguing with a straight face that we don’t need any fixes.

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