New Initiatives to Restore Calm

Financial Times, SEC Unveils Temporary Shorting Ban
Financial Times, FSA Bands Short-selling of Banks
New York Times, Treasury to Guarantee Money Market Funds
Reuters, SEC Issues Temporary Ban on Short Sales

News of the U.S. government’s rescue plan for troubled financial institutions buoyed markets early Friday, while financial regulators got to work issuing a gaggle of temporary orders to help restore calm amidst a storm of financial uncertainty.

The Securities and Exchange Commission (SEC) has temporarily banned the short-selling of 799 financial stocks, including AIG, Berkshire Hathaway, Loews and Blackstone Group. A short sale occurs when a seller borrows a stock, sells it, and then buys it back at a lower price. The goal of the short sale is to take advantage of price declines. The SEC has put some of the blame for the current financial crisis on short sellers, accusing them of driving down share prices of firms like Lehman Brothers and AIG. Financial regulators across the pond are following suit in banning short sales, including the U.K.’s Financial Services Authority, Ireland’s stock market regulator, and Australia (who banned “naked” short sales – short sales where sellers do not borrow the stock first and then fail to deliver to the buyer).

Hedge funds have warned that the ban on short sellers could make it very difficult for banks to raise new capital, and shares could become more expensive to trade because hedge funds will be unable to provide more liquidity to the market. But regulators maintain that the rules will provide much-needed stability in an otherwise volatile market.

The Treasury Department is [temporarily] guaranteeing monkey market funds, which have traditionally been safe and risk-free investments but have felt the stress of the current market turmoil, up to $50 billion to ensure their solvency. The Federal Reserve is also expanding its emergency lending program to support the $3 trillion in troubled funds. Money market funds are mutual funds, required by law, to invest in low-risk securities, and typically invest in government securities, certificates of deposits, commercial paper of companies, and other highly liquid and low-risk securities. The payments will be guaranteed by the Exchange Stabilization Fund which was set up in the 1930s to intervene in foreign exchange markets.

Questions for discussion:

1) Is market intervention absolutely necessary? Are the hedge funds right in claiming these rules will create artificial prices and hurt banks trying to raise capital?

2) Are these “temporary” rules really temporary, or do you think this is the beginning of an era of nationalization?