The Credit Default Swap dysfunction --- Santoli agrees!
Michael Santoli of Barrons, a sister publication to the Wall Street Journal, has a weekly column on the equity markets that is often insightful on trends, often wrong on stock picks, and always a believer in the wisdom of the markets absent regulation. Today's column caused me to sit up straight in my chair and read again, and slowly.
Posts here for over a year have criticized the elimination of the short sale uptick rule in the summer of 2006 as throwing out a regulation that worked for almost 60 years. In the absence of this rule it was much easier for short sellers to gang up on a stock at any given point in time and create almost risk free gains. Almost I say because there is always a last trader to cover that gets hit. Without the uptick rule it was easier to take advantage of "planted rumors" and do damage to a stock that could be viewed as vulnerable. These short attacks, with no pause for the stock to refresh, could have nothing to do with the economic performance of a company but only with a competition and some would say collusion among traders to make money. Michael Santoli always unequivocally supported the elimination of the uptick rule because in his view it had no impact on the longer term performance of a stock.
Here at ENS there was also an obsession for perhaps two years about the flaws in mark to market accounting rules in illiquid markets. There is no question that under many circumstances mark to market is a best practice. In illiquid markets, however, it allowed small trades by speculators and by panicked or deeply troubled investors to set required prices for an overall security. This created a downward spiral of panicked selling among the stressed and the need for large financial institutions to write down parts of their portfolios significantly, irregardless of the economic value of the security. Michael Santoli always supported across the board mark to market accounting --- the market always knows best.
The latest intense focus here has been on the credit default swap market and the fact that there are no required linkages to the underlying securities. The subprime mortgage securities market was deeply flawed but when all was said and done there were at least $60 billion of CDS's written against $2 billion of subprime CMO's. A fair market could have unwound this in some type of orderly way but with the massive CDS bets it was chaos. That pricing chaos now infects virtually all consumer asset backed securities. I could keep going on this issue but much of my commentary has been recently posted here. Shock of the day was that Michael Santoli, of Barrons, agrees. He writes today that "curbing CDS purchases by investors with no economic exposure to a company", or sovereign I would add, is like establishing the infield fly rule in baseball 100 years ago. By that he means that it is such a completely obvious opportunity to violate fair play that it should be banned. You can see his column at http://www.barrons.online/ today.
Others with broader platforms will hopefully write about this and the SEC will hopefully pay attention. It's so simple and it could do more almost immediately to put some order into these markets than any amount of bank bailouts and popular handouts. Santoli would probably not make a statement that aggressive, but even he agrees that the need for change is obvious.
Posts here for over a year have criticized the elimination of the short sale uptick rule in the summer of 2006 as throwing out a regulation that worked for almost 60 years. In the absence of this rule it was much easier for short sellers to gang up on a stock at any given point in time and create almost risk free gains. Almost I say because there is always a last trader to cover that gets hit. Without the uptick rule it was easier to take advantage of "planted rumors" and do damage to a stock that could be viewed as vulnerable. These short attacks, with no pause for the stock to refresh, could have nothing to do with the economic performance of a company but only with a competition and some would say collusion among traders to make money. Michael Santoli always unequivocally supported the elimination of the uptick rule because in his view it had no impact on the longer term performance of a stock.
Here at ENS there was also an obsession for perhaps two years about the flaws in mark to market accounting rules in illiquid markets. There is no question that under many circumstances mark to market is a best practice. In illiquid markets, however, it allowed small trades by speculators and by panicked or deeply troubled investors to set required prices for an overall security. This created a downward spiral of panicked selling among the stressed and the need for large financial institutions to write down parts of their portfolios significantly, irregardless of the economic value of the security. Michael Santoli always supported across the board mark to market accounting --- the market always knows best.
The latest intense focus here has been on the credit default swap market and the fact that there are no required linkages to the underlying securities. The subprime mortgage securities market was deeply flawed but when all was said and done there were at least $60 billion of CDS's written against $2 billion of subprime CMO's. A fair market could have unwound this in some type of orderly way but with the massive CDS bets it was chaos. That pricing chaos now infects virtually all consumer asset backed securities. I could keep going on this issue but much of my commentary has been recently posted here. Shock of the day was that Michael Santoli, of Barrons, agrees. He writes today that "curbing CDS purchases by investors with no economic exposure to a company", or sovereign I would add, is like establishing the infield fly rule in baseball 100 years ago. By that he means that it is such a completely obvious opportunity to violate fair play that it should be banned. You can see his column at http://www.barrons.online/ today.
Others with broader platforms will hopefully write about this and the SEC will hopefully pay attention. It's so simple and it could do more almost immediately to put some order into these markets than any amount of bank bailouts and popular handouts. Santoli would probably not make a statement that aggressive, but even he agrees that the need for change is obvious.
posted by John Borden at 2:59 PM
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