Thursday, July 17, 2008

SEC Protects Primary Dealers From Naked Short Selling

I find it ironic that the SEC has issued restrictions on short selling of primary dealers yet oversight on naked short selling has been nonexistent over this past cycle. Are there any nuggets of knowledge to take away from this?

To me, this is quite possibly where the Fed has drawn the line in the sand. I view this as the potential "protected" list that will be guaranteed a bailout if needed. In other words, if a financial institution isn't on this list, the Fed could very well not be willing to save it. Bank failures will increase and the demarcation line must be drawn somewhere. So, it's plausible to hypothesize that bank failures not on this list will be subject to FDIC insurance protection in the event of a failure.

On this general topic, you might find it interesting that the XLF banking exchange traded fund did 351 million shares yesterday. You read that right. The average daily volume for the XLF before this crisis started was between 2-5 million shares a day. Just a small volume increase of tens of thousands of percent. Volume on the ETF has picked up substantially as large trading desks are surely using this as a broad market shorting vehicle for banks but 351 million is still magnitudes above the current average volume.

So, why was volume so high yesterday? There were probably a few contributing factors but one major one could be that many large trading firms were using naked short selling to drive down financial shares. The large volume bump could have been those firms covering their shorts. In other words, what they were doing wasn't legal and firms didn't want to be caught under the SEC's renewed interest in enforcing the law. Isn't deregulation grand?
posted by TimingLogic at 6:54 AM