What was so bad about the uptick rule?
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The U.S. Securities and Exchange Commission has proposed about a dozen different restrictions on short sellers in the past few days, including an outright ban for financial stocks, but it hasn’t replaced the primary restriction on short sellers that was in place for most of the century.
The “uptick rule” or “tick test” required short sellers to sell at a price above the last price paid for a stock, or at the price of the stock’s last trade if it was higher than the previous price. The rule had been in effect since 1938, but the SEC removed the rule last year, on July 6, 2007, after saying it was “obsolete.”
The SEC studied its removal, running a pilot program on 1,000 stocks starting in May 2005 through April 2006, a year when the bull market was just getting going and the Standard & Poor’s 500 index rose about 13 percent on its way to record highs. Now that the S&P is down more than 14 percent since the beginning of this year, getting rid of the rule has been blamed for increased volatility, and calls for its return could get louder as the process of market re-regulation gathers pace.
“The SEC did one of the dumb things that has been done to hurt this market, doing away with the uptick rule,” said Don Hodges, president of Hodges Capital Management.
The uptick rule was removed just as subprime mortgages started their meltdown in August last year, which would have been a great time for investors to get short. They did, and short interest has risen to record highs this year.
So the remaining question then is, did the uptick rule really do anything? Check out this chart of nonblock money flow for listed U.S. stocks.
It shows stocks purchased at higher prices (upticks) versus stocks purchased at lower prices (downticks) for the last two years. That big switch in the middle toward downticks hit around July 6, 2007.
These new short selling restrictions are much more complicated, and haven’t been studied. Maybe it would have been just as easy for the SEC to bring back the uptick rule.
-By Emily Chasan and Mark McSherry
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AMEN! Sometimes the most simple solution to a problem just can’t be seen.
They’re working day and night (and doing a good job) -even though I hate to resort to these socialist actions. But it was necessary. I don’t short stocks, but I do know that shorts are necessary. Are they too young to know what the up-tick rule is?
Bring back the uptick rule! It prevents basically sound institutions from falling victim to overaggressive bear raids. If Bush operatives had not suspended it, they would not now be talking about “rescuing” the victims of their own, let’s face it, stupidity. Heaven help us all . . . Imagine calling for help and then seeing the Three Stooges show up, sirens blaring.
It would seem that the removal of the uptick rule was the accelerant along with bad investments, Wall St. rumors that made the situation so urgent. It is noteworthy that SEC head Cox isn’t out in the mainstream media in the United States – he’s not going to want to be answering questions about this debacle and the role his oversight agency played in this all.
I am totally convinced that on 10/9/08, the first day after the short sale ban was lifted that I was a victim of a bear raid of my stock holding (SLM) and sold out on margin as a result,thus causing me to suffer a realized loss of over $413,000 dollars. I can’t imagine why the SEC thought it was a good Idea to eliminate the uptick rule.
Short sellers are not driving the prices in today’s markets. Let’s look at some data. Between July 15th and November 14th, short shares outstanding fell by more than 5 BILLION shares on the NYSE, and by more than 3.5 billion on the Nasdaq. But during that time, the S&P 500 fell 27.5%, and volatility (as measured by the VIX) more than doubled, increasing by 132%. How exactly did short sellers BUYING back 8.5 billion shares of stock cause the market to collapse and volatility to rise?
The answer is that they didn’t. The uptick rule only affects stocks. But we have seen dramatic increases in volatility of oil prices, bonds, and just about every other asset class. How can anyone believe that the higher volatility of stocks was caused by the repeal of the uptick rule, when volatility is higher everywhere?
Proponents of the uptick rule essentially claim that “because stocks fall, short sellers are to blame.” Between September 19th and September 26th, Washington Mutual fell by 96%. Is it those manipulative short sellers again? Well, no–short selling was banned in hundreds of financial companies during this time, ncluding Washington Mutual. Let’s be clear: Short sellers are not driving price. In fact, the data shows that short sellers serve to regulate price– they are part of the few who are buying when stocks go down, and selling when stocks are going up. Stocks go down because they are overvalued. There was too much leverage, and too many companies didn’t bother preparing for anything besides the best of times. Let’s stop blaming the short sellers already.
Eric Newman – TFS Capital, LLC