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Never underestimate the ability of Congress to focus on a problem’s symptoms rather than its cure. By seeking to revive the archaic “uptick rule” that limits short selling of stocks when their last price move was down, Congress is doing just that.
Recent events have fooled even some well-informed observers into connecting the uptick rule’s demise with the market carnage. It was first established in 1938, the beginning of a long climb back for equities from the beating they took in the Great Depression. It was eliminated in July 2007, just weeks before big financial institutions began a sickening descent. This post hoc ergo propter hoc fallacy does not hold up to scrutiny though.
The rule may have thwarted bear raids in the 1930s before swaps, ETFs and computerised trading existed and prices moved in eighths of a dollar. Today, it is no more than a speed bump. Indeed, the uptick rule was eliminated for 1,000 liquid stocks in 2005 with no ill effect in the last two years of the bull market. Conversely, outright bans on shorting companies such as Lehman Brothers and Fannie Mae could not halt their demise. Long investors are just as motivated to dump shares in a worthless business as short sellers.
Making short-selling more difficult will eliminate some intraday volatility, but at the cost of increased market friction and making activities such as selling convertible bonds cumbersome. The premise that making it easier to sell a healthy company’s stock endangers its survival is flimsy unless clearly illegal activities, such as rumour-mongering, accompany it. Some such as discount brokerage king Charles Schwab support reinstatement as a way to protect small investors, but this is disingenuous. Would he have supported a “downtick rule” when naïve daytraders chased technology stocks that seemed only to go up?
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