Thursday, August 09, 2007

SEC Decision Risks Dangerous Stock Market Instability, Savings of Millions

Thursday, August 9, 2007

Boulder, CO - Despite the recent high stock market volatility, a 1938 rule restricting short selling of stocks was ended last month by the Securities and Exchange Commission, putting at increased risk the savings and investments of millions of Americans. The Uptick Rule, as it is known by brokers, was put in place in response to political pressure following the Wall Street Crash of 1929. During that historic crash, the market dropped 40% in slightly over 2 months, and would lose about 90% of its value about 4 years later. Many blamed this event on short sellers.

Selling short is a market play by someone who bets a stock price will decrease. The short-seller borrows a stock from a broker. The stock is then sold. After the value drops, the short seller repurchases the stock at the discounted price, thereby making a profit. When institutional investors, or large numbers of investors, attempt to hedge against the risk of market declines by short selling, the result is downward pressure on stock prices.

The Uptick Rule required that the trade's execution was only permitted if the price had increased one increment. This prevented short selling in continuously falling markets. Without this rule, market falls are accelerated. Since short sellers benefit the more prices fall, one can easily recognize the increased potential for accelerated short selling and accelerated market declines in a panic selling environment without the Uptick Rule.

The SEC initiated this change after a pilot study, and after receiving only 27 formal comments. According to the SEC, in one of those comments, the New York Stock Exchange "noted its concern about unrestricted short selling during periods of unusually rapid and large market declines....[and mentioned] that the effects of an unusually rapid and large market decline could not be measured or analyzed during the Pilot [program]."

Gregory Drahuschak, first vice president of Janney Montgomery Scott Inc, a 175 year-old investment company, stated, "if you had asked any desk trader at a brokerage firm what the potential outcome of the rule change could be, the answer uniformly was that it would increase volatility. And so it has." Referring to last week's selloffs he said, "The market drop was not caused by the rule change, but there is little doubt that it made the slide occur faster than it might have otherwise."

America First Party
1630 A 30th Street #111
Boulder, Colorado 80301


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