Tips: The Sideshow
Kudlow's Money Politics

On July 6th, 2007 the SEC suspended the Uptick Rule. The Uptick Rule prevented stock traders from shorting a stock on a downward tick of the stock price. It was implemented by Joseph Kennedy when he was chairman of the SEC. Kennedy himself was a famous short seller and bear raider. It was done in the wake of the 1929 market crash in order to curb some of the volitility in the stock market and prevent short sellers from launching bear raids on stocks in a downward spiral.

Selling a stock short is the process of borrowing shares from a broker, market maker, specialist, or electric exchange, and immediately selling them with the hope that the stock will decline and you will be able to repurchase the shares at a lower price, give the exchange back the shares you borrowed, and pocket the difference between the shorted price and buy back price.

For example, let's say I decided to short sell Countrywide (CFC) and borrowed then sold shares at the price of $35 per share. That was Countrywide's shareprice less than a month ago. Today, CFC is trading around $20. I could by back the shares for $20, give them to the broker, and keep the $15 in profit. So if I shorted 1000 shares of CFC I would have made $1500. Mind you this is a simplified example and there are other rules that apply to short selling as well as closing dates.

The point here is that there is a debate raging in the stock trading community about whether or not the suspension of the Uptick Rule is leading to this current market crash. Make no mistake, this is a crash. The Dow Jones Industrial Average (DJIA) has lost over 1200 points in less than a month.

Market insiders say the Uptick Rule is not to blame for the market tanking. To a degree I tend to agree. Bad fundamentals are to blame for the current crash. Too many financial institutions tied their money to the subprime mortgage market and are now paying the price. Even if the Uptick Rule wasn't suspended, the markets would be in decline.

But would they have declined this much, this fast? I tend to think not. Suspension of the Uptick Rule seems to be leading to an all out bear raid on the markets with traders shorting everything in sight.

Take a look at these graphs:

As you can see, short interest is at an all time high.

Seems to me that the bears are fully in control of this market and that thanks in part to the suspension of the Uptick Rule, they will continue their short raids for at least the rest of the year. The markets would have declined regardless but I doubt they would have declined this fast if the Uptick Rule had remained in place. Some say the Uptick Rule simply delayed the inevitable and that the end point, a bottoming of the market, is the same in each case.

I tend to disagree though I am not a market guru. My thinking is that if the Uptick Rule were in place, the decline in stocks would have been stretched out over a couple of months rather than a few weeks. This could give time for institutional investors to repair some market fundamentals as well as time to analyze new economic data. This in turn could have helped temper the sour mood of Wall St.

But make no mistake about it. Money is being made right now even as the markets tank. The bearish short sellers are licking their chops. There doesn't look to be any solid support until about 12,000. I would not be surprised to see the market pull all the way back to 11,000. Shorts can get greedy too and tend to over short and turn overly bearish when there is no reason for it. This leads to short covering rallies which we will see in the coming weeks; a few days here and there of surprised market upturns. It will puzzle the news anchors as they smile and say "the Dow Jones Industrial Average was up 85 points today...a good day for Wall St". But most traders will realize it's just a temporary short covering rally.

The mood on Wall St has turned bearish and for good reason. Deficit spending is near all time highs, our national debt stands at $9 Trillion, the dollar keeps going down in addition to the economic threats the U.S. faces from China's consideration of dumping dollars to Iran's mulling of trading oil in Euros. Not to mention the occupation of Iraq, Afhghanistan, and pending bombing of Iran.

You will notice that the Bush Administration continues to tell people that the economy is strong. They operate under the premise that perception is reality and if you tell a lie often enough people will believe it. But Wall St is harder to fool and if they decide the market has been artificially inflated for years now, not much will change their mind except a quick charge to the bottom.

I would argue we've been living in an artificial market since 9/11. It was the attacks on September 11th that caused markets to crash leading the Fed to drop interest rates down to 1%. This spurned on the housing market and mortgage industry.

It was an elaborate house of cards built to make the economy appear strong. It worked for a time but we all knew the day would come when the house came crashing down. Not because it had to, but precisely because it was a house of cards. The housing market could have very well maintained itself if people weren't so greedy. But as refinancing, mortgaging, and buying homes reached a fevered pitch, there seemed to be no top.

Brokers were telling prosepctive home buyers that their houses would gain 20% a year in value. They were lending to people that had no business buying a mortgage. They were financing volitile ARMs telling people not to worry...they could always refi next year...when their house went up in value...Or they could cash out and take the profits.

Ultimately it is the invididual's fault for getting into a mortgage they could not afford. But in many cases the brokers are just as much to blame. If the get rich quick fly by night brokers weren't so greedy, it's likely the housing market wouldn't be tanking today.

But there are other factors as well that are going to weigh the economy down. No one talks about the doubling of food prices or the drag high fuel prices are having on the economy. No one seems to talk about inflation but it's there, lurking in the corner.

Wages are stagnant and despite what Bush says, real, decent paying jobs are not being created.

What this means in the long run is that Democrats are likely to inherit very tough market conditions and a battered economy come 2008. Dare I say even a massive recession.

This will be used as a bully club to hit Democrats over the head with. And as suggestions are made on how to fix problems, Wall St and Republicans will have to be dragged along kicking and screaming.

The budget will have to be balanced and taxes will have to be raised, namely the dividend tax and the taxes on the top 5% of income earners. This will have the major financiers seething mad. They may even purposely sabotage the market and jack up energy costs just to punish the government.

It's all part of an all too familiar cycle. Once the budget is balanced, dare I say once we have "surpluses", once the economy is on solid footing, and real jobs are being created, Republicans will start crowing again about the need to tax cuts and big breaks for corporate America. This will pave the way for the next Republican shift as early as 2012 but certainly by 2018.

And then we'll do it all over again with a few wars mixed in for good measure.

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