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Streetwise Professor

September 27, 2008

Unintended–But Totally Predictable–Adverse Consequences

Filed under: Derivatives,Economics,Politics — The Professor @ 11:13 pm

The SEC’s short sale witch hunt has burned some innocent victims–convertible bonds and options. Short selling of stocks is an essential hedging tool for these instruments, and the short sale restrictions have therefore undermined widely used hedging strategies, thereby driving the investors that rely on them from the market.

Brilliant move. The effect on convertible bonds is particularly unfortunate. Just when financial institutions are looking to recapitalize, throw a monkey wrench in a part of the capital market many banks have tapped to strengthen their balance sheets.

This is a perfect illustration of the dangers of regulators taking a cartoon view of the world, where evil villains are responsible for all the chaos in fair Gotham. In their monomaniacal focus on the manipulative potential of short selling, Cox and his his minions have completely overlooked its benefits, and implemented policies that have inflicted substantial collateral damage on other portions of the financial market, including parts of the market that could facilitate fixing problems at the institutions allegedly protected by the regulations–banks. This is particularly tragic given that the rationale for the policy is based on anecdote–to put it as charitably as possible. Remember what George Stigler said: The plural of “anecdote” is not “data.”

The collateral damage inflicted by a policy with a threadbare rationale (or should I say it is nakedly short of a rationale?) provides a chilling reminder of how regulation can make things far worse, rather than better. Apparently Chris Cox wants to regulate the financial markets in the worst way, and has succeeded.

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2 Comments »

  1. [...] The SEC’s ban on short selling is a perfect illustration of the dangers of regulators taking a cartoon view of the world, where evil villains are responsible for all the chaos in fair Gotham. In their monomaniacal focus on the manipulative potential of short selling, Cox and his his minions have completely overlooked its benefits, and implemented policies that have inflicted substantial collateral damage on other portions of the financial market, including parts of the market that could facilitate fixing problems at the institutions allegedly protected by the regulations–banks. This is particularly tragic given that the rationale for the policy is based on anecdote–to put it as charitably as possible. Remember what George Stigler said: The plural of “anecdote” is not “data.” ~Streetwise Professor [...]

    Pingback by Quote of the Day | 1800blogger — October 1, 2008 @ 6:40 am

  2. [...] pressures.” Gee, but that seems very, very similar to what I wrote on 27 September in “Unintended–But Totally Predictable–Consequences.” Specific use of the term “Collateral damage”? Check. Specific use of the term [...]

    Pingback by Streetwise Professor » Should I Sue, or Just Remember That Imitation is the Sincerest Form of Flattery? — October 11, 2008 @ 8:41 pm

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