How To Fix the Broken US Economy (Part 2)

By Guest Author Bill McGinnis, CFA

[Bill’s series continues with a discussion of how short selling contributed to the fall of the once-mighty Citigroup.]

The following text was submitted to the New York Times as an Op-Ed piece on November 23, 2008. It was not published. At the time, Citigroup stock was in a freefall. The stock ultimately stabilized, only to go into freefall again in March 2009.

Short Selling – An Immediate Change is Necessary to Save Citigroup

Over recent months, this country has lost several distinguished financial companies and we risk loosing Citigroup and others in the coming weeks. Why? The 2007 change in the short sale rules has played no small role. While the economy has had a severe negative impact on financial companies, the crisis of confidence caused by plunging stock prices has been just as severe. In recent weeks, the obvious target has been Citigroup.

Untempered short sales drove the price of Citigroup to as low as $3.05 per share last week from $37.50 just over a year ago. Many in the media are questioning whether the company can survive. Despite raising $80 billion of new equity this year (including $25 billion from the government) the company’s market capitalization is currently only $20 billion. The company certainly has credit quality issues, but it is highly unlikely that they are of the magnitude suggested by the current stock price. Having worked as an investment analyst specializing in bank stocks for over a decade, I find it hard to believe the current low price is justified. Based on the $25 billion provided to Citigroup by the government, I believe government officials would concur.

After approximately 70 years of consistency regarding short sale rules, the uptick rule was eliminated in July 2007. Within a year, we had companies being driven out of business. The people telling the government that short sales are not affecting share prices are as wrong as the ones who said speculation wasn’t involved in driving oil to $140 per barrel. It’s nonsense.

The uptick rule was eliminated after only a six-month test … on a limited number of companies…in a bull market…during a period of abnormally low market volatility. Of course the test didn’t show any negative impact. As soon as we hit a bear market, the problems caused by eliminating the rule became clear. Hedge funds controlling billions of dollars can endeavor (and possibly conspire) to drive companies into the ground. It’s quite possible that these same investors have also been planting the media rumors questioning the viability of the same companies whose prices they are driving down.

Citigroup and other financial companies have requested that the short selling rules be changed. This is not just another request for a handout. This is a request for protection from predators. If the financial system of one of our allies was being attacked by another country or terrorists, we would likely consider all measures, including military action. Yet, when our own system is under attack, we do nothing.

How much has deregulated short selling already cost the American people? Why is the government spending trillions to avert a financial collapse while allowing a practice that works completely against every effort to stabilize the financial system? A limited number of investors are benefiting at the expense of our country. Reinstating the uptick rule could be done immediately and at no cost.

The government needs to immediately reinstate the uptick rule. Citigroup and other companies integral to our economy may not survive until Christmas without it.

This segment is part 2 in the series : How To Fix the Broken US Economy
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