Tune in to the Shorts

No more regulations. Just listen to the short sellers.

Would the ghastly global economic crisis been avoided had the regulators listened to the short sellers? Seems likely.

In July, Christopher Cox, chairman of the SEC announced a plan to curb improper (naked) short-selling to limit the activity of short-sellers. Mr Cox seems to be implicitly blaming the shorts for the unprecedented fall of bank, ­government-sponsored agency and brokerage stocks over the past year – even though they were the very group that warned of the dangerous credit cycle and its consequences.

Now for a little history on shorts. Perhaps the first case dates to 1609 when the Dutch trader, Isaac Le Maire, targeted the shares of the shipping company Vereenigde Oostindische Compagnie (the Dutch East India Company). VOC was the first multinational corporation in history and had broad powers. Nonetheless, Le Maire, concerned about threats of attack by English ships, sold VOC’s shares short. After learning about Le Maire’s tactics, the stock exchange governing VOC’s trading banned short-selling (although the ban was later revoked).

In the early 1630s, the Dutch economy fell into a depression following a speculative peak in the trading of tulips. Again, short-selling raised the ire of regulators, many of whom saw it as magnifying the effect on the Dutch economic downturn. As a result, England banned short-selling outright.

Hedge fund manager Douglas Kass thinks instead of more regulation, the chairman and investors should begin listening to what short-sellers have to say about our economy and credit markets.

What do you think?

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Can the Fed beat a bubble?

Hardly. Says Dan Gross in Slate.

"….So how could the Fed stop bubbles? One way might be for Federal Reserve chairs and other officials to use their credibility to talk down investors from making poor bets. But even on its best days, the market doesn't listen to reason. During a bubble? Forget about it. A bespectacled jargon-dispensing economist standing astride the rails and yelling stop isn't likely to have much effect on a runaway locomotive. Alan Greenspan gave his famed irrational exuberance speech on Dec. 5, 1996. But the Dow Jones Industrial Average and the NASDAQ ran up 82 percent and 288 percent, respectively, in the three years after the speech—before popping….

…..The Federal Reserve is an organization much like any other—run by human beings with fallible judgment, driven by consensus, and less than congenial for ontrarians. In bubbles, skeptics are always marginalized while the promoters are anointed as seers. And when a bubble gets loose, it infects every institution: banks, the media, and, yes, the Federal Reserve. The Fed, in the person of Alan Greenspan, failed to diagnose the Internet bubble accurately, and it misjudged the housing bubble, too. The Fed, in the person of Ben Bernanke, failed to see the credit mess coming. And once that crisis hit, the Fed failed to accurately gauge its scope and depth. When the party really gets going, we all drink from the same punch bowl…."

Bubbles occur because no two minds think alike, yet are easily influenced. Everyone abhors herd syndrome but has it ever stopped? Accept bubbles as natural phenomenon like rain or sunshine. Perhaps it's a bit like life itself that has ups and downs. Attempts to regulate nature have only met with disaster. So the best way to deal with a bubble is to acquire stronger defenses when the storm rages. We will have casualties, but it will leave some scope for faster rehab - in preparation for the next one.

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