Markets down - a rule change - then markets up

Here's my take on why the stock market bolted up out of the blue and gold got hit at the exact same time.

We are now in the stage of this crisis where the financial authorities are going to be using every trick in the bag to keep asset prices up and in safe territory.

Every trick except honesty and transparency, that is.

Today's rule change was to limit 'short sales' of stock, and to further hint that maybe they'll be eliminated altogether.

For any individual or fund that is short, the market, which is a perfectly reasonable method of controlling risk and is every bit as legitimate a method of speculating on stock price movements as being 'long,' even the prospect of such a rule change requires immediately shedding any short stocks as rapidly as possible.

[quote] Sept. 18 (Bloomberg) -- U.S. stocks rose on prospects the government is formulating a "permanent'' plan to shore up financial markets and regulators and pension funds took steps aimed at curbing bets against banks and brokerages.

Morgan Stanley and Goldman Sachs Group Inc. erased most of their earlier plunges, as regulators in the U.S. and U.K. stiffened rules against so-called short sales and the nation's three largest public pensions stopped lending shares of Goldman and Morgan Stanley to short sellers.

There it is. The UK went a full step further:

[quote] Britain's stock market regulator on Thursday banned short selling in financial companies and said it might extend the ban to other sectors. The move followed the Securities and Exchange Commission's curbs on the practice that went into effect Thursday morning.[/quote]

What do you get when you force shorts to cover? A short covering rally, of course.

The part about all of this that is so transparent to people who are familiar with markets is that prices are no longer as meaningful as they used to be. Stock prices and institutions are now deemed to be "too important to fail," and so they are officially supported.

Other things like gold are deemed to be a threat to the larger plans because of the way that they send signals that are counter to what the officials are trying to convey.

Here's a perfect example from today. Note the precise, interlocked behavior of gold prices and stock prices. Right at 12:00, both assets reversed violently in the opposite directions from where they were headed. Either you have to believe that "investors" collectively decided to take an opposite view from the one they held only minutes earlier, or you have to suspect that a far smaller number of interested parties made the decision to reverse the direction of two important markets.

Occum's razor; one of these two possibilities is far simpler and more probable than the other.

I see no real reason, at this stage, why gold should trade in direct opposition to stocks like this, so when I see a near-perfect correlation like this, I get slightly suspicious. Especially when it comes on a day when the Treasury ups its debt offerings by $100 billion, and several money market funds experience a run and consequently halt redemptions. Those don't seem to be especially supportive of the action charted above.

My view is this: There's going to be a tremendous battle between trying to prop paper assets for as long as possible while preventing clear signs about the true state of affairs. The name of the game now is "preserve confidence."

Given that we have a Ponzi economy and money system, this is no small matter. The key here for us is going to be keeping a clear eye on what's real and what is fake.

The stock rally (and gold slam) above shares more in common with Donald Trump's hair than it does a fine work of art.

That's my take.

This is a companion discussion topic for the original entry at

Fair disclosure: I have big shorts and puts on the market.
That being said, I’m very disappointed with this afternoon’s outcome. Not because I lost money today, but because my legitimate investing strategy is being scape-goated as the cause of the financial meltdown. I’m not short because I want businesses to fail, I’m short because they are insolvent.
This rally just makes no logical sense and is just the result of more Government propping up. How far are they going to go? Why don’t we just change the name from “investing” to something more like “winning”.
I’m about to through my hands up and quit all together.

Are puts going to be affected by this new rule?

Surprise, surprise, the mainstream seems to have mostly ignored this juicy little tidbit. There is a complete article about the markets’ move today on Yahoo Finance titled Stocks surge on report of entity for bad debt</a href> that doesn’t so much as mention any potential rule change. Blame, I mean credit, for the rally goes to the possibility of a new entity to buy up bad debt.

I have to agree with Reubenmp3, here. If you micro-analyze the days' trading, you'll see that there was a minor rally when the news about shorts came out, but after about a half an hour, the market began an abolutely predictable slide back down the slope as the shorts were covered.

Then along about 1:30 came the rumor that Paulson was trying to create a revival of the RTC - a government repository for bad debt. The rumors were unconfirmed at first, but gained strength throughout the day. And why wouldn't the bankers be happy about that? The government wants to remove the risk? Great. I'm back in business.

The government is insolvent, but the illusion of invulnerability seems to be holding. So, the markets rallied hard.

What, me worry?

Puts aren’t affected. My frustration is that the Fed doesn’t believe there should be any “downside” to investing.

I wasn’t saying that I particularly agree with the commentary in the article, I was just pointing out that (predictably) some of the more mainstream (or is that main street?) press was paying no attention to the rule change rumors and only focusing on the “good” news that would have contributed to a rally.

I will note that when I looked at the charts in my ThinkDesktop software (from ThinkorSwim, minute by minute chart), I was seeing the time of reversal in the DJI, SPX, and NDX as 1:00 pm - could be a difference of EDT compared to CDT. Things really went crazy during the last hour of trade - the professional shorts may have decided to wait to cover until their usual peak of activity. The live spot price for gold seemed to hold up around $900 until about 2:30pm EDT, then plunged. It is currently holding at about $855 (Price chart from

These observations are not meant to distract from Chris' main point - that every conceivable button and lever is being pressed and pulled to keep things from completely melting down, and it is being done more and more openly. It is only a matter of time before enough people put two and two together and focus on what actions are being hidden right in plain sight, and what those actions mean.

All the best,


to disagree with the general view of what the gov’t is trying to do. Normally, as a hardcore capitalist, I would disagree with them tinkering with the capital markets like this. I used to use shorts more for true hedging purposes to reduce risk for example, capital structure arbitrage where I would be short stock, long senior bonds (KMV model) or long volatility by being long options or embedded options and shorting stock on a delta. The move to end short selling was never meant to be permanent. The problem today (other than what Chris is so correctly pointing out) is a confidence problem more than anything else. While Chris’ predictions of mid to long term trends are inevitable, today… today, the problem is investor confidence and liquidity. Ending shorts for a period of time is not a knock on short speculating, it is trying to control abusive short selling where a number of large funds are supposedly trying to profit from this precarious environment. Normally there’s nothing wrong with that but the implications of systemic failure is too big of a risk to let a few funds run their money making experiments on the effect of leverage and size in an illiquid market. Do you think it can’t be done? I only have to point out collapses and actions of guys like Brian Hunter and Amaranth to make my point. The short selling ban is meant to be temporary and to help restore confidence. There’s no time or room to debate the merits of capitalism purity… we have a world to try and sustain for at least a few more years. This is a smart move, as is the Resolution Trust… either they masterfully bought out AIG and FNM before introducing another entity that will make their AIG investment sing, or they are really like deer caught in headlights. The problem with the liquidity is that no market means institutions are forced to mark things at 0 which is not a real reflection of value so having a gov’t fund that gives bids is a cheaper way to try and save the system than to buy out every company that gets into trouble. My bet is that they put a time limit on how long the ban from short selling will last.

I certainly agree that the take-home message for the day is that all the stops are coming out. We shall see how long it all lasts.

So, as a hardcore capitalist, you like the idea of a system that when unregulated results in a small group owning everything? Or are you like most and confuse capitalism with the idea of markets? Not meant as a slight…just curious.

I can hardly believe what I’m reading and can hardly imagine that our representatives understand the true repercussions of what they’re agreeing to…

Paulson, Bernanke and Securities and Exchange Commission Chairman Christopher Cox asked us would we agree to do legislation that would create the authority within the federal government somewhere to buy up these illiquid assets,'' said Representative Barney Frank, chairman of the House Financial Services Committee We said `yes,’ we think that’s important to do because the consequences of not doing it are so bad.‘’

…taken from Bloomberg

on my description of being a hardcore capitalist is the best you can do to defend against the main message of what I was trying to get across, then you’re already lost. I will try and repeat it very slowly for you… at times, to preserve what free markets we have, to avoid systemic failure, it is important to realize the mistakes we have made and occasionally make difficult decisions to correct things WITH the knowledge that the attempt to fix that situation is NOT to be embedded within the system we are trying to maintain. As humans, we will always make mistakes and hopefully learn from them. There are things we can do to avoid this from happening again and they are not necessarily in opposition to what Chris is so correctly trying to point out in this amazing Crash Course series. I realize you may be thinking that these types of interventions could create more problems down the road if the markets are made to believe that there is such a thing as being too big to fail or that the gov’ts will do what they can do bail overlevered companies out of their troubles but then again, what did you expect the governments to do? sigh In your world, you would rather innocent people suffer continuously from the mistakes of others in the hopes that everyone has learned their lessons and should get on with their sorry lives. That just isn’t the way the real world works. Perhaps I should have rephrased the nuance of my post in that whether I agree with the governments actions or not, it really is irrelevant and I can understand why they did such a thing. Like Chris, I am an optimist and hope that some of these things they are doing going to buy us some more time so that more people can be convinced that Chris’ forecast of the future can be avoided.

if short covering rallies are doomed to fade, since insolvency, not liquidity is the issue, what if people just hang on to (small) short positions until this craziness settles down? Won’t the market come back to the downward spiral anyway? Every fix the Treasury has tried has only worked for a short while, and each for less time than before.
I don’t think they can stop the slide. The unwinding is the correction for the run-up. One way or another we are all going to pay, maybe for a generation or more. Even Cramer~!- Gag - seemed to hint that people should take their profits Friday and be very careful, like more REALLY BAD NEWS was in the making.
SPECULATION: Did the Feds see a perfect storm coming on the horizon which was going to be our modern “BLACK MONDAY”? I just have a feeling they are not ‘out of touch’ but in fact know exactly what is brewing and are therefore pulling out all the stops.
I read that China doesn’t allow short selling and (if true), that hasn’t stopped their market from falling.
So maybe since no new shorts-at least temporarily, will be allowed, hanging on to short positions will still prove profitable. Yah, MAYBE!!
Of course naked shorts are another scumbag kind of animal…

An article on how these bailouts are seen from elsewhere:
From the New York Times
Some quotes:

  • “They will say that even the standard-bearer of the market economy, the United States, negates its fundamental principles in its behavior.”
  • “I understand why they do it,” he added. “But they’ve lost credibility to some extent in pushing for opening up overseas markets to foreign competition and liberalizing economies.”
  • "...The safety net they are spreading seems to widen every day with no end in sight.”
  • So, this GIANT mortgage-related bad debt eater… another AIG? Sounds more like another blank cheque to be paid by washing out the dollar or by my great-grandchildren.
    Sounds like they’re just lighting a longer fuse to a bigger bomb.
    How can anyone have confidence in this country anymore?
    Maybe it’s time to move to Canada.

    You think the US Government and Federal Reserve are a bunch of morons!?
    Here’s to let you know that the clowns at the Reserve bank of Australia are no better.
    After hiking its target rate to 7.25% back when the ‘credit crunch’ hit, the RBA only a week or two ago reduced the target rate and has now had to ‘inject’ 15 odd billion of its funny money into the financial system this week.
    I don’t think it’s just the US dollar that’s toast.

    Can anyone help me understand the following, taken from an article on MarketWatch? The way this is pitched, it seems like they are trying to say, “look, we are helping out at a terrible time and we will sell these currently deeply discounted assets later” – seeming to me to imply that the government, in the end, will not come out badly because they won’t lose money on the subsequent sales. Am I reading this right?
    “The Journal reported that the entity would not mirror the Resolution Trust Corp., which was created to address the savings and loan crisis in the 1980s. Rather than hold and sell the assets of failed banks as the RTC did, the new entity would “purchase assets at a steep discount from solvent financial institutions and then eventually sell them back into the market” through an auction, the Journal reported.”

    While I can see why many argue with the Fed’s actions, all I suggest is to consider the alternatives… to keep true to the pristine rules of capitalism, would you rather give up trying to buy some time before the inevitable collapse or let the market free fall into depression for 10 years… it’s easy to criticize. Anyways, if you find it difficult to trade this market or if you have longs you’re trying to get out of or have options where not put/call parity is out the window, you aren’t alone. Take a look at what is happening in the currency markets which are not affected by these rule changes and if you see the dollar continue to decline against a rising equity market, then you know this is a fake rally.

    I can see how sarcasm can be interpreted from my questions. It was not meant. However, from your response, I see that you may not grasp some basics. First, these ‘mistakes’ as you put it, are not mistakes. It is a by product from the lack of regulation, or rule making to guide the system. ALL markets have rules, who sets them is the question. Is it by those who own all the capital (unregulated) or by those who are on the bottom end and create the wealth trough labor (regulated). Sure there are issues of corruption within regulatory powers, but there can be controlled checks and balances. Unregulated capitalism absolutedly results in a corrupted system since a very small group can leverage their economic power. So these are not mistakes. It is funny how those that scream for less regulation and free markets are the first to call for government bailouts for their failing system. Bailouts only stress the middle class more…now and in the future. It is like someone who owes you money jedi mind tricking you into paying yourself back…makes sense? Let the these investment systems fail, and direct those bailouts to the individuals who were bilked into believing the economic mumbo jumbo of the last 30 years. Rebuild a national economy again. One based upon rebuiding infrastructure (which always pays economic dividends), manufacturing (yes this is very important), and energy research. There is boom that could occur, but it would be a working boom.No matter how you look at it, regulation after the Great Depression worked! It grew the middle class and lead to more equity in our democratic institutions. The way we avoid this again is in the same manner…an intelligently regulated economy, where the government strategically spends money in economic downturns and provides ‘access’ to health care and education; those things that are fundamental in a egalitarian democracy. Or we can have it your way and have an economic dictatorship.
    A good read is “A Brief History of Neoliberalism” by David Harvey.

    You’re right - The name of the game now is “preserve confidence.” Keep it up until Jan. 20, 2009 (or maybe Nov. 5th) to dump it in the lap of the next president. If I were Obama or McCain, I’d be trying to throw the race because whoever wins is going to take on the biggest catastrophe we’ve faced in decades, or more likely centuries, as a country. I pity the fool.
    btw - I just found this site and think it’s the BEST. Great stuff.