Wall Street’s top cop, Chris Cox fired an unprecedented blast in the air to protect wounded Fannie Mae and Freddie Mac from the Wall Street buzzards that feed on weak stocks.
The chairman of the Securities and Exchange Commission aimed his new crackdown yesterday specifically at short sellers who’ve made quick kills betting that shares of the two mortgage giants will drop, especially if they’re trashed by whisper rumors and other stock manipulations.
Despite Cox’s surprise move, shares of the two firms skidded again sharply yesterday, with Freddie Mac falling 26 percent to $5.26, and Fannie Mae tumbling 27 percent to $7.07.
While short sellers may be profiting from the shares’ declines, many investors are simply bailing out because they fear that common shareholders will be wiped out in any bailout plan.
Two plans being floated now include throwing the firms in a temporary government receivership and raising private capital by giving new investors all of the equity. In both scenarios, current shareholders would be left with nothing.
However, Cox zeroed in on so called “naked” short selling – a controversial practice when speculators set up a trade that a stock will drop in value but bypass the normal rules for making such bets.
The wild-west trading style is being cited for hastening Bear Stearns’ fall, being a factor in Lehman Brothers’ 80 percent decline, and is believed to have contributed to the huge selling and trading in Freddie and Fannie.
Normally, a short-seller speculator first borrows his targeted shares from a brokerage holding the shares in its accounts, and signs a guarantee to return the shares along with a hefty fee, within a period of time, say 30 days.
Next, the short seller dumps the shares, and hopes that the price will fall so that he can repurchase them in the open market at a cheaper price, and pocket the difference before he returns the shares to the brokerage. That’s regarded as a legitimate trading practice.
In “naked short selling,” speculators skip the crucial step of actually borrowing the shares or delivering them, avoiding the expense of the borrowing.
And when some short-sellers launch elaborate rumor campaigns to drive down the stock, it becomes stock manipulation.
“Since it’s impossible to police false rumors, the next best option for protecting fragile financial institutions is to halt short-selling for a time being,” analyst David Trone at Fox-Pitt told Bloomberg.
Hedge-fund chief Bill Ackman yesterday said he’s betting against Freddie and Fannie but there was no indication that he was engaged in “naked short selling.”