Death by 10-Percent Increments

It’s hard for me to take Jim Cramer on CNBC seriously. In repose (a state he is rarely in), Cramer looks like an adult. But in his natural state (which seems to range from fired-up to lunatic frenzy), he screams and shouts and gyrates and throws things.

And he does all this while discussing something that’s very important to most people: their money. More specifically, their investments. Serious stuff to be discussed by a man who seems intent on being mistaken for a whirling dervish.

But it’s only fair that I admit that when the man is right, he is absolutely right. So, what is it that he’s right about? The need for an uptick rule in the stock markets.

A quick refresher course on what the uptick rule is (or, more accurately, was): The rule was put in place in the late 1930s and was in force for 70 years, until President George W. Bush’s SEC chairman, Christopher Cox, pushed for its elimination. What did the rule do? The rule required an upward move before short sales were allowed. This makes short sales tougher and helps prevent market freefall.

As Chuck Jaffe wrote recently on MarketWatch, “A short sale is a bet against a stock; it typically involves borrowing shares, selling them, and waiting for the stock’s price to decline before ‘covering’ the trade and buying the shares back on the open market. The short-seller keeps the difference between the higher selling price and the lower repurchase price.”

So, a rule that seemed to work quite well for 70 years was tossed on the scrap heap by the Bush administration, according to Jim Cramer, due to academic models for the market. In late February, the SEC enacted an alternative to the traditional uptick rule: A circuit breaker is triggered when a stock’s price is down by 10% or more from the prior day’s closing price.

Jaffe writes, “Now, apparently, the idea is to limit the damage at 10% in a day. Considering that most investors would be happy making 10% on a stock in a year, waiting to slow a bear-driven frenzy until the stock has moved 10% seems a bit like closing the cage after the bears have looted the kitchen.”

The new rule, as Jim Cramer said (or was it screamed?) on his show, just allows short sellers to make a company worthless at a rate of 10% a day — something he felt they would be quite happy to do. And as Senator Ted Kaufman (D-Delaware) said on Cramer’s show, once the short-sellers get going, there is nothing to stop the average investor from dumping stocks in a panic.

In other words the new rule accomplishes nothing. It allows the SEC to claim that it is doing its job by enacting rules to protect shareholders when in reality, it’s done nothing of the sort.

The SEC, currently under Chairman Mary Schapiro, has forgotten its mission. It’s not taking care of Corporate America’s shareholders. If short-sellers can destroy the value of stock currently held by Joe and Jane Average, and they can destroy it under the new rule, how is the SEC protecting them?

Pardon me for sliding into self-promotion here, but I spent a lot of time studying Dwight Eisenhower while writing Lead Like Ike: Ten Business Strategies from the CEO of D-Day. And there is one thing Ike almost never did — he never forgot the mission. He stayed focused on it and only did what he needed to do to succeed at his mission.

The one time Ike forgot led to disaster: Operation Market-Garden. In September 1944, only three months after D-Day, the Allies launched a daring Airborne invasion of Holland, seized multiple bridges and attempted to dash along 64-miles of highway and over the Rhine into Germany. Unfortunately, the Airborne forces were unable to seize and control the last bridge, the one over the Rhine itself. (This led to the title of the book by Cornelius Ryan and the movie, A Bridge Too Far.)

Market-Garden was a failure; the Allies didn’t make it over the Rhine; and their forces were cut to ribbons. It was the only major defeat of Eisenhower’s entire post-D-Day campaign. But, bad as the failure and loss of life were, they weren’t what made Market-Garden a disaster.

Operation Market-Garden, even if it had been a smashing success, would not have advance the Allies’ cause. It would not have furthered their mission. Like the new uptick rule, Market-Garden didn’t address the real problem — the Allies needed a deepwater port to supply their forces. Without the port, they couldn’t have supplied troops once they went over the Rhine into Germany. It’s pointless to invade a country if you can’t really invade.

And it’s pointless to pass rules that don’t actually have any chance of protecting the people they are supposed to protect.

Ike never let his focus wander after Operation Market-Garden. As a result, he accepted the German surrender only eight months afterward.

Wouldn’t it be nice if Chairman Schapiro got the SEC refocused and got back into the shareholder protection business?


One Response to Death by 10-Percent Increments

  1. Jill Quist says:

    Good one. I’m currently reading a book called House of Cards by William Conan about the fall of Bear Sterns. You might enjoy it.

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