Bears, Bulls, Chickens and Pigs: wOw’s Wall Street Weekly with Liz Peek (Week of 7/14)

Editor’s Note: Liz Peek is a financial columnist.

Wow, what a week! The markets turned topsy-turvy in the past few days, just as it appeared that nothing could stop the bank stocks from heading to zero and oil topping $150. Isn’t it amazing how quickly things can change?

There’s quite a bit of disagreement about why the tables turned so abruptly, but here’s one explanation: On Tuesday SEC Chairman Chris Cox testified before the Senate Banking Committee and announced a crackdown on the practice of naked short selling. This activity involves someone selling a stock they do not own in hopes of buying it back later at a lower price. By law, the seller is supposed to locate the shares he needs to cover the sale, but in reality the authorities have had almost no way to keep tabs on this. 

So, the SEC issued an order saying that short sellers in certain financial stocks including Fannie Mae and Freddie Mac (which were evaporating) must now actually borrow the shares they need to cover the sale ahead of time. This means incurring a fee, and also means that the wanton naked short selling that had been taking place had to stop.

Bingo, the bank stocks staged the biggest rally in that sector’s history the next day, and posted a similarly exciting gain Thursday. Why? For months Wall Street has been abuzz about hedge funds staging so-called "bear raids" on Bear Stearns, Lehman Brothers, Freddie and Fannie and a whole slew of smaller financial stocks. This means they piled on, selling the stocks short continually, until the prices broke down below other investors’ stop-loss orders and risk-management levels, triggering yet more selling. It’s a pretty effective tactic in a fragile and scared market, and especially so since the SEC revoked something called the uptick rule last summer. Without drowning you in technicalities, the uptick rule was a law adopted in 1938 to keep short sellers from wreaking havoc in a declining market. It said you could only sell a stock short when the price moved higher. Many investors think the uptick rule should be re-imposed, and so do I. It acts as a braking mechanism and can help stem the slide in a panicky market.

On a related note, something pretty amazing happened this week. Apparently Dick Fuld, the CEO of Lehman, and Alan Schwartz, head of Bear Stearns, both questioned Goldman Sachs’s CEO Lloyd Blankfein about his firm’s role in the slide of their companies’ share prices. Though it has been widely reported that rumor-mongering helped put Bear out of business, this was, to my knowledge, an unprecedented, personal sort of inquiry. (Normally Wall Street washes its dirty linen behind closed doors.) 

Perhaps not coincidentally, SEC Chairman Cox also took aim at the dissemination of false information for the purpose of manipulating stock prices. He said that for the first time in the SEC’s 74-year history the agency had tried and convicted a trader for spreading damaging and false lies about a company while selling the stock short.

So surprise, surprise; not everyone on Wall Street is a good guy, and not everyone follows the rules. I actually am quite cheered that Cox took such a hard line. 

Anyway, the financial stock feeding frenzy abated, at least temporarily, and thank heavens. For sure, not all of the market’s bounce stemmed from the short-selling clampdown. Oil prices tanked more than 10% over four days because of (continuing) indications that demand has been crimped by high prices. These data points have been surfacing for months, as readers of this column know, but the market paid attention this past week to an unexpected inventory build in gasoline and other products, and in reports indicating that U.S. demand for oil is running about 2% below year-earlier levels.