Tuesday, September 23, 2008

Black September, Black Wednesday, Black Bear

Wednesday, September 17, 2008 will be known as 'Black Wednesday' even though the stock market hit bottom on Thursday. Black Wednesday symbolized the temporary failure of top flight capitalism in America. As with collosal failures in many businesses and markets, greed was at the core of this meltdown. Speculators and short sellers are two of the primary culprits. Greedy home purchasers and unscrupulous mortgage bankers are right up there with them. We add speculators to the list because of their manipulation of the oil market at the worst possible time. Maybe they already picked the bones of the housing market and needed a commodity to manipulate. They speculated before Black Wednesday and now they are coming back for more. The price of oil rose by $25 in one day a week after Black Wednesday.

Short selling is the selling of a security (stock) that the seller does not own. The stock is borrowed. Short sellers assume that they will be able to buy the stock at a lower amount than the price at which they sold short. They make money by basically buying low and selling high, pocketing the difference between the lowered stock price and the higher price of the borrowed stock when it is returned. Selling short is the opposite of going long because short sellers make money if the stock goes down in price. Doesn't it sound like a racket? It also begs for insider trading. One might know that a stock price is going to drop by studying a company, but if one has inside information that the company is in trouble, it would be very easy to profit from short selling. Clearly something is wrong with the practice because the Securities and Exchange Commission (SEC) has banned short selling of 799 stocks for ten days, which will probably be extended for 30 days. Some think this is catering to CEOs who don't want investors betting on their stock falling. Maybe when the markets stablize, short selling can return, but there should be more oversight because of its inherent structure that can be abused.

More on Selling Short, Wiki: To profit from a stock price going down, short sellers can borrow a stock and sell it, expecting that it will be cheaper to repurchase in the future. When the seller decides that the time is right (or when the lender recalls the shares), the seller buys back the shares in order to return them to the lender. The process generally relies on the fact that securities are fungible, so that the shares returned do not need to be the same shares as were originally borrowed. The short seller borrows from their broker, who usually in turn has borrowed the shares from some other investor who is holding his shares long; the broker itself seldom actually purchases the shares to lend to the short seller. The lender of the shares does not lose the right to sell the shares.

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