Investor confidence not too helpful
Once again someone in charge — Mary Schapiro of the U.S. Securities and Exchange Commission this time — is going on about how they are making changes in order to “preserve investor confidence.”
As if this were in some way a good thing.
I would feel a whole lot better if instead the SEC were talking about making investors more sceptical.
The SEC on Wednesday moved by a 3-2 vote to place additional limits on short selling of stocks, the practice of betting on a decline in a given stock by borrowing shares, selling them and contracting to buy them back later at what the seller hopes will be a lower price.
The new curb would serve as a so-called circuit breaker for shares that have fallen 10 percent or more in a trading session.
“It is a rule that is designed to preserve investor confidence and promote market efficiency,” said Schapiro, the SEC’s chairman.
Now Schapiro is in part talking about confidence among investors that markets are fair, efficient and not subject to abuse. That’s absolutely crucial and the SEC should be ferocious in going after abuse and in ensuring transparency. The SEC’s reason for existing is to ensure that U.S. markets are places where everyone gets a fair shake. That makes people willing to give their capital to strangers who have promised to use it productively and share the fruits.
This urge to buttress confidence however, sadly often bleeds into an effort to prop up confidence among investors that everything is in pretty good shape after all, or even worse in attempts to deny investors access to information that might make them believe that the prospects of a specific company are poor.
Short sellers are the much needed vinegar in the overwhelmingly sickly sweet sauce that passes for analysis in financial markets. They give investors valuable clues that all might not be well with a given company, and so long as they don’t sell shares that they can’t actually lay their hands on, spread false rumors or fail to disclose they ought to be mostly left alone, though tightly monitored.
If you read through the submissions to the SEC by members of the public — usually in the securities business or in companies who raise money through it — who support the new rules there is a recurring theme: that short selling might ruin a business by giving people the idea that it is in trouble and impairing its access to capital.
Ultimately that is what short sellers are hoping and ultimately we will all be better off if less capital is allocated to weak firms rather than to strong ones. Among the loudest in complaining about short selling in 2008 were representatives of the securities industry. Executives at both Lehman Brothers and Bear Stearns were both vociferous in blaming their problems on short sellers. But neither firm was brought low by short sellers; they were brought low by reality, a reality which short sellers grasped before the rest of us.
AN OVERCONFIDENT INDUSTRY
The entire securities industry is hugely biased towards over-confidence; in fact you could make an argument that its revenues depend in substantial part on over-confidence. Buy ratings on U.S. stocks are five times more common than sell ratings, even now after tighter regulation of Wall Street and following the worst bear market since the Depression. That ratio was certainly even higher two years ago and much higher over the past decade, a period in which precious few investors in stocks in the United States have been able to avoid losing money.
And the overconfidence isn’t just among analysts trying to gauge company performance, it is crucially rampant among investors who wrongly think that they, rather than their neighbor, will be able to beat the market by active investing.
That confidence, that an investor will somehow not only be able to identify a good active manager but also know when that manager will change from good to bad, underlies the entire active investing industry. In aggregate this confidence proves to be misplaced.
So, in an industry with so much demonstrable over-confidence the question has to be asked: why expend so much energy clamping down on some of the few negative voices?
My guess is that people confuse the power that confidence has in interpersonal relationships with some real power that is independent of psychology. You might be able to convince your neighbor that you can fly, but it works less well with the air, much less the ground.
It is also true that the systemic overconfidence benefits the people who work in the system more than those who trust their capital to it.