Worried About Stock Market Volatility?

We've seen a pretty wild ride this week on the stock market.  Yes, there has been troubling news coming out the sub-prime mortgage market (in my opinion, the bad news is that there IS a sub-prime mortgage market), but the wild extremes of highs and lows has been a little scary.

Why?

Because wild negative swings in value are what cause margin calls, and margin calls are what start runs.  It was margin calls that started the subprime crisis, as lenders starting calling their chits and the mortgage companies became cash-strapped.

So why the wild swings?

Larry Kudlow, writing over at National Review Online, has an answer-- and it is not good.  It seems the SEC, run by former Representative Chris Cox, has ditched the "uptick rule".

Savvy veteran investor Mike Holland keeps asking a question that no one seems to be asking, much less answering: Why in the world did the SEC revoke the “uptick” rule in early July?

Famous short seller and patriarch of the Kennedy clan, Joe Kennedy, created the uptick rule over seventy years ago during his tenure as FDR’s first SEC chairman. While many likened Kennedy’s stint to a fox guarding the hen house, Kennedy certainly knew how to stop the bear raiders from trashing the stock market.

The uptick rule was put into place forbidding traders from shorting stocks on a price downtick. Until last month, if you wanted to short a stock, you needed to wait for an uptick in the share price. This move stymied potential bear raids on stocks. It worked for over seven decades. Many Wall Street veterans also believe it dramatically reduced stock market volatility.

In today’s context, is it purely a coincidence that Chris Cox’s new SEC “no uptick” rule made its debut at the same time that stock market volatility has gone gangbusters? Are hedge fund traders shorting stocks on down ticks? This could be adding huge momentum to downsized price movement. It could also be putting ordinary mom and pops investors on Main Street at great risk to the machinations of Wall Street professionals.

Nobody knows for sure what’s going on here. I’d like to get some comments on this. Meanwhile, I’m still looking for more info on this whole point.

But it seems to me that abolishing the uptick rule was an unbelievably lousy idea by Cox’s SEC. It appears the rule’s revocation may have exaggerated downside pressure on the stock market.

So now we have a situation where we have one organ of the national government making an unquestionably stupid decision -- dropping the uptick rule -- and another organ of the national government (the Federal Reserve)  makes another questionable decision -- dropping the discount rate a half-point -- to "fix" it.

Unfortunately, I think the Fed rate drop will only make it worse, not better.  The bears smell blood in the water, and they will begin shorting again once the euphoria wears off.  Remember that it was pathetically cheap credit that really started this whole sub-prime rush 5 years ago to begin with.  These "no money down" and subprime loans came about because there was an excess of cash available to lenders.

The mortgage market does not face a shortage of inventory (houses to sell) or customers; it faces a crisis of confidence because of the outright larceny that the subprime loan industry has represented due to the massive fraud still plaguing us through "flipping" and "no-doc" loans.  Until the industry cleans up its act and starts adhering to sounder business principles, the industry will be a septic pit for crime and corruption.