Question for Wall Street types.

[fivepennies]

I don't pretend to know anything about investing, but there was a conversation on a radio show last night about the removal of Glass Steagall and how destructive that was to the market. A caller, claiming to be a former floor trader, said that even worse was the removal of the "uptick rule" and he went on to explain its effect on short sales, although most of it went over my head.

So this morning I went looking:

The uptick rule (rule 10a-1) was established in 1938 – in the depths of the Great Depression that followed the 1929 stock market crash – during the administration of SEC Commissioner Joseph P. “Joe” Kennedy Sr. Kennedy, the first commissioner of the SEC, implemented the uptick rule after examining what role short-selling played in a 1937 stock-market break.

Short-sellers are essentially betting that a company’s stock will fall in price. They “borrow” the shares from another investor and sell them, reaping the proceeds at what they believe is a “high” price. If the price falls, as they expect, they can buy the shares back at a lower price (which is known as “covering” their short sale) and replace the block of stock that they borrowed.

Their profit is the difference between the proceeds from the initial short sale higher price and what they then had to spend to cover their short sale (as well as brokerage commissions).

With the uptick rule, the objective was to prevent groups of short-sellers from, in effect, ganging up on a stock for the solitary intent of driving it down as far as possible. In such a gambit, the short-sellers hope to create a steep enough sell-off to cause panic selling by the other shareholders, which would lead to a total freefall in the stock price.

Short-selling restrictions were removed from about one-third of the major listed stocks in a year-long study conducted in 2004. This test was conducted to see how much of an impact there would be from the uptick rule’s removal.

After a roundtable discussion about the results in September 2006, the SEC decided to eliminate rule, which it did the following July. According to the SEC, the uptick rule wasn’t really needed to prevent manipulation and actually seemed to reduce a stock’s liquidity.

“The general consensus from these analyses and the roundtable was that the commission should remove price test restrictions because they modestly reduce liquidity and do not appear necessary to prevent manipulation,” the SEC reported. “In addition, the empirical evidence did not provide strong support for extending a price test to either small or thinly-traded securities not currently subject to a price test.”

However, when the uptick rule was eliminated, the U.S. stock market experienced a massive surge in volatility. Hedge funds took extreme advantage of the ability to not have to wait for an uptick in the price of a stock before they moved to sell it short.

Almost immediately after the uptick rule was abolished, investors began to clamor for its reinstatement. Indeed, throughout much of last year, politicians, investors and other public figures began pushing for the rule to be put back on the books.

In 2008, there was outcry from top public figures such as CNBC-TV’s “Mad Money” host Jim Cramer, as well as such elected officials as U.S. representatives Gary Ackerman, D-N.Y., Mike Capuano, D-Mass., and Carolyn B. Maloney, D-N.Y., as well as presidential candidate and U.S. Sen. John McCain, R-Ariz., who all pushed for reinstatement of the uptick rule.

The heavyweight mergers-and-acquisitions law firm Wachtell, Lipton, Rosen, & Katz may have best-summarized proponents’ desire to see the rule reinstated.

“Short-selling is at record levels,” the New York-based firm said in a statement. “We ask the SEC to take urgent action and reinstate the 70-year-old uptick rule. Decisive action cannot await a new SEC chairman – there is no tomorrow. The failure to reinstate the uptick rule is not acceptable.”

The groundswell of support for reinstatement of the uptick rule spilled over into the New Year, and even escalated as the markets whipsawed U.S. investors. On Feb. 25, for instance, Bernanke, the U.S. central bank chief, declared his support for the restoration of the uptick rule. On March 10, the SEC and U.S. Rep. Barney Frank, D-Mass., (and the chairman of the House Financial Services Committee) jointly announced plans to restore the uptick rule.

http://moneymorning.com/2009/05/04/uptick-rule /

.... and then nothing happened. Why not?

[banned from Kos]

1. In March 2009 the market turned around around and shorting went out

of vogue (until this month).

Its kind of like those who want no regulations on oil drillers until a BP Gulf disaster. GOPigs are already back to complaining about the EPA.

[fivepennies]

3. I understand the noregsrepugs

are all about removing all safeguards and regulations, but if the volatility was so awful in 2008 when calls were being made to reinstate the uptick rule, why did they wait until March 2009 to say "see, it wasn't needed after all"?

And its obvious, even to me, that it was and is truly needed.

[PoliticAverse]

2. The SEC went with an 'alternative uptick rule', see...

http://www.sec.gov/news/press/2010/2010-26.htm

Also the SEC cracked down somewhat on naked short selling by enforcing
regulations that required short sellers to actually have located
borrowed stock to short.

[fivepennies]

4. Okay,

so what was this guy talking about? The market is totally screwed up, why? What's missing?

[nomb]

11. Short selling is more complex, and hence easier, than you know. I can take and sell your stock

I can take and sell the stock from your account without your knowledge or agreement - or even paying you for the privilege. Legally.

There is not a thing on this earth that prevents the Goldman's of the world from shorting anything in any quantity they want.


And only the Goldman's can stop me from doing the same. Fact.

[izquierdista]

5. Uptick rule is kind of passe

It can be defeated by program trading. For example, you can have your computer enter and quickly cancel a large order, that for all intents and purposes, creates a phantom uptick before you slam the market with your big sell order. For every trading rule that can be enacted by the exchange to dampen speculative tricks, there are dozens of traders willing to find a crank to turn that will game the system. Remember that a large part of Enron's profits came from gaming the system for trading electric power.

Rules sound good after everything has turned to shit, and then people are wishing for the return of Glass-Steagall, the uptick rule, etc., but rules only work when everyone agrees to abide by them. When rules get a dirty reputation through constant calls for deregulation, then you can expect that people gaming the system will end up with more money than they know how to spend.

The real way to stabilize the system is to make speculation less rewarding. Not necessarily by rules on trading, but when capital gains were taxed as ordinary income and the top tax rate was over 70%, there was much less of a bubble-and-crash economy.

[nomb]

9. The Magic Bullet on that one?

Enforce the old rules regarding tradeable markets.


Simply make all orders good for 1/3 of 1 second through the exchange matching engine. What used to be called while the breath is still warm.


The Market would immediately stopped being gamed on that front. It would be like turning a light on watching the roaches scramble for safety.

[izquierdista]

13. Better yet

Have all the traders stand out on the curb and go through the issues one by one, having each buyer shout out his bid and each seller crying out his size and offer. Then when you get done with ZZZ Technologies, everyone goes home until the next day. At that speed, it won't pay to game the system.

[fivepennies]

10. Capital gains taxed as ordinary income!

That's the only thing that ever made sense. So why aren't they doing that?

[banned from Kos]

15. very astute post. The uptick rule is a minor nuisance as was

Glass Steagle.

The root cause of the 2008 meltdown was millions of bad subprime and Option ARM loans going bad. Yet no one talks about 20% down on mortgages at all.

[nomb]

6. The uptick rule was a real problem for high-frequency algo traders.

Fact is, the SEC completely dropped enforcement of it for electronic traders around 1999.

They did not tell anyone, just stopped enforcing it.


We kept violating it in error and then when no one called (which they routinely do for all manner of trades that get flagged) we opened up the throttle and completely ignored the rule.


During the tech crash that created single contract NASDAQ100/Cash arbitrage profits as high as $50,000 a "car".

Frankly the government sucks on this. Glass never should have been killed and the old rules should never have been discarded for trading. It was a disaster for society.

[fivepennies]

12. Absolutely a disaster for society.

But there are many who say Wall Street's mere existence is the primary disaster. They will always find loop holes to screw us out of house and home, whether we personally invest in their gambling casino or not.

[sfpcjock]

7. W's SEC Chair, Cox, let Banksters and Hedge funds naked short sell...

the greatest American companies into the ground and make money doing it in 2008. Cramer used to talk about it.

[fivepennies]

14. I've watched that happen over many decades

without really knowing how they were destroying all those good solid companies, but when the promoters of 401k programs came hawking their wares at my place of employment I smelled a rat and refused to sign on the dotted line. IMO, the "make money by letting us gamble with your earnings" hawksters should come complete with warning labels tattooed on their foreheads: SCAM ARTIST in bright scarlet letters.

[Tuesday Afternoon]

8. bkmrkng to read later.