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Manipulating The Markets

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July 17, 2008

On Wednesday night, Jon Stewart pointed out that President Bush saw fit to hold a news conference about the economy at exactly 10:20 a.m. on Tuesday, July 15.  As luck would have it, this was the very minute when Federal Reserve Chairman, Ben Bernanke, was to begin his testimony before Congress about the state of the economy.  Stewart deftly contrasted the “spin” message presented by Bush with the sworn testimony of the Federal Reserve Chairman.  Bush was obviously out to blunt any negative impact Beranake’s testimony might have on the markets.  The 180-degree difference between Bush’s spin and Bernanke’s reality was hilarious.  Regardless, Bush’s plan didn’t work.  The Dow Jones industrial average dropped 92 points (.84 percent) on Tuesday and the Standard and Poor’s 500 index (which includes many financial stocks) fared worse.  Wednesday saw a dramatic shift in the markets due to a drop in the price of oil – the only thing that ever gives the stock market a boost these days.

July 15 was also the day when the Securities Exchange Commission enacted a new, emergency rule against “naked” short-selling of financial stocks.  As Dane Hamilton reported for Reuters, the rule drew mixed reactions among hedge fund managers and traders.  Hamilton described the SEC’s reasoning that:

…  naked short selling, which is putting in a short stock order with no intention of actually borrowing it to drive down the price, may have contributed to this year’s collapse of Bear Stearns and sharp declines in other financial stocks this year.

As Mr. Hamilton explained:  this new, temporary rule was enacted to protect 19 financial stocks, including battered mortgage guarantors Fannie Mae, Freddie Mac and a number of banks, against “a substantial threat of sudden and excessive” stock price movements.  What other industry could count on the Federal Government to protect it from the predatory tactics of a handful of unscrupulous “short sellers”?  Some of these traders make multiple short sales on a single share of stock.  The net effect of this is that they are actually “counterfeiting” stocks to be sold short and bought back at a lower price, before anyone might realize the shares never existed.

Investors have been victimized by such tactics for decades. However, until now, the SEC has been of little or no help in regulating these tactics.  In an article from the March 23, 2007 issue of USA Today, Matt Krantz reported on the boasts of MSNBC’s TV host, Jim Cramer, about how Cramer had used “short” sales to manipulate stock prices:

A lot of times when I was short (stocks) at my hedge fund … meaning I needed it (the stock) down …I would create a level of activity beforehand that would drive the futures … It’s a fun game, and it’s a lucrative game.

If you are wondering how the 19 financial companies covered by the July 15 emergency SEC rule, were able to obtain the kind of protection afforded by that measure, you may want to consider some of the observations made by Lisa Lerer in her July 17 article for Politico.com:

If you want to know how Fannie Mae and Freddie Mac have survived scandal and crisis, consider this: Over the past decade, they have spent nearly $200 million on lobbying and campaign contributions.

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When their stock prices took a dive last week, their government allies extended another helping hand with a plan for the Treasury Department, the Federal Reserve and, possibly, Congress to shore up the companies.

It’s nice to see the SEC doing something to protect investors from predatory trading practices.  The only reason the SEC is protecting investors in this instance is because investors are the collateral beneficiaries of a rule written to protect 19 financial institutions.   We just don’t see enough government action to stop the manipulation of the markets on a broader scale.  Worse yet, when the President gets on TV to compete with the Federal Reserve Chairman’s testimony in order to paint a contrasting, more favorable picture of the economy – what do you call that?  How about:  manipulation of the markets?