Paul Krugman, "The Hijacked Crisis": Paul, Here's A Short-Run Fix

Paul Krugman is furious with the Procrastinator in Chief, and it becomes ever more obvious from week to week. In his latest New York Times op-ed entitled "The Hijacked Crisis" (http://www.nytimes.com/2011/08/12/opinion/the-hijacked-crisis.html?_r=1&hp), Krugman lets loose with the following slap in the face:

"For more than a year and a half — ever since President Obama chose to make deficits, not jobs, the central focus of the 2010 State of the Union address — we’ve had a public conversation that has been dominated by budget concerns, while almost ignoring unemployment. The supposedly urgent need to reduce deficits has so dominated the discourse that on Monday, in the midst of a market panic, Mr. Obama devoted most of his remarks to the deficit rather than to the clear and present danger of renewed recession."

Ouch. But let's ignore Obama, who is becoming increasingly irrelevant with every passing week, and focus on Krugman's other contention that "self-proclaimed centrists" are also to blame for our economic sorrows:

"Check out the opinion page of any major newspaper, or listen to any news-discussion program, and you’re likely to encounter some self-proclaimed centrist declaring that there are no short-run fixes for our economic difficulties, that the responsible thing is to focus on long-run solutions and, in particular, on 'entitlement reform' — that is, cuts in Social Security and Medicare. And when you do encounter such a person, you should be aware that people like that are a major reason we’re in so much trouble.

For the fact is that right now the economy desperately needs a short-run fix. When you’re bleeding profusely from an open wound, you want a doctor who binds that wound up, not a doctor who lectures you on the importance of maintaining a healthy lifestyle as you get older."

Ouch, again. Well, I avoid characterizing myself as left, right or center, but I do offer overnight medicine for America's economic woes.

The European Securities and Markets Authority has announced that short sales, i.e. the sale of unowned stock by traders in order to benefit from an anticipated decline in the share price — will not be permitted in Belgium, France, Italy and Spain effective Friday, adding to the temporary ban on shorting currently in effect in Greece and Turkey (see: http://www.nytimes.com/2011/08/12/business/global/europe-considers-ban-on-short-selling.html?_r=1&hp).

I do not advocate an outright ban on short sales in the US, as this would interfere with the efficiency of markets, i.e. interfere with the pricing of shares in accordance with their true value. I do, however, support reinstatement of the "Uptick Rule," which would prevent downward manipulation of share prices by market sharks, which has cost many small companies their lives, thereby adding to unemployment.

The Uptick Rule went into effect in 1938 in response to market abuses that threatened the health of the US economy, and prohibited short sales of securities except on an "uptick". As summarized by the SEC:

"Rule 10a-1(a)(1) provided that, subject to certain exceptions, a listed security may be sold short (A) at a price above the price at which the immediately preceding sale was effected (plus tick), or (B) at the last sale price if it is higher than the last different price (zero-plus tick). Short sales were not permitted on minus ticks or zero-minus ticks, subject to narrow exceptions."

The Uptick Rule was cancelled in 2007, thereby enabling hedge funds to short shares, i.e. sell shares they did not own, in almost unlimited, immediate quantities, and permitting them to benefit from resultant investor panic in almost any given traded company.

Example: Micro-cap company "X" has designed and patented a revolutionary widget. Recently, the achievements of "X" have made their way into the news, and its shares have risen. Farmer Joe, who attends night school and reads the financial news, decides to buy 1,000 shares of "X". However, unbeknownst to Farmer Joe, Slick Eddy at Hedge Fund "Z", who couldn't care less about the merits of company "X"'s widgets, has also noticed the rise in the share price of "X". With almost unlimited resources behind him, Eddy borrows "X" shares from various financial institutions and begins to sell vast quantities into the market, causing a precipitous decline in the market price of "X". Eddy then blocks any rally in the share price and immediately sells shares at the bid after any significant purchase. Worried by the huge downswing in the price of "X" accompanied by unusually high volume, and also concerned that at the end of each trading day "X" always goes down (Eddy always sells into the market in the last seconds of trading), Farmer Joe dumps his shares at an enormous loss ("Someone must know that something's wrong at 'X'"). Having succeeded in panicking Farmer Joe and other small investors in "X", Eddy buys back the shares at a significantly lower average price than that at which he sold them, resulting in enormous profits for Hedge Fund "Z". Eddy's bosses note his "fine" work and reward him with bonuses as the shares of "X" tumble.

Of course, there are those who will say that ultimately the stock market is "efficient", and the price of "X" will recover to an appropriate level. However, in the process we have witnessed the flow of wealth from Farmer Joe and other small investors to Hedge Fund "Z" and Slick Eddy.

Also, consider the damage to company "X", which, owing to doubt raised by the run on its shares, is suddenly unable to raise additional funds to finance production of a new line of widgets, declares bankruptcy and fires its staff.

Why has the Uptick Rule not been reinstated? Obviously, there are powerful lobbyists opposed to its reenactment, yet this requires immediate action.

As I wrote in an earlier blog entry (http://jgcaesarea.blogspot.com/search/label/Uptick%20Rule), looking back at Glass Steagall and the Uptick Rule, it turns out that our forefathers gained much wisdom in their attempts to pull the US out of the Great Depression and to prevent a recurrence of this tragedy. Today, their wisdom is ignored.

Paul wants a short-run fix for the economy? Here, at least, is part of it: Reinstate the Uptick Rule. The message will not be lost on the American economy.