Securities and Exchange Commission's
temporary ban on short sales of financial stocks may give several banks the time to step back and evaluate deals entered into or pursued at breakneck pace during the financial crisis gripping U.S. markets this week.
The bankruptcy of
fire sale to
Bank of America
and the near collapse and government takeover of
American International Group
wreaked havoc on the stock market this week, particularly the last two investment banks left standing:
Shares of Morgan Stanley and Goldman Sachs hit 52-week lows on Thursday as concerns mounted about the viability of both investment banks.
decline led the bank to seek out possible merger partners, including
, as a means to protect itself for possible extinction.
"I know all of you are watching our stock price today, and so am I," wrote Morgan Stanley's CEO John Mack in a memo to employees on Wednesday, a day after the investment bank announced decent quarterly earnings. "There is no rational basis for the movements in our stock or credit default spreads.
"What's happening out there? It's very clear to me -- we're in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down," Mack wrote. "You should know that the management committee and I are taking every step possible to stop this irresponsible action in the market."
The SEC, in conjunction with the U.K. Financial Services Authority, on Friday took temporary emergency action to prohibit short-selling in financial companies "to protect the integrity and quality of the securities market and strengthen investor confidence."
In an emergency order, the SEC said its action will apply to the securities of 799 financial companies. The move, effective immediately, will remain in place until Oct. 2, but could be extended, the SEC said.
"Over the past few weeks, our publicly traded member banks and bank holding companies have seen precipitous drops in stock prices, extremely high trading volumes, and huge spikes in failures to deliver," said Edward Yingling, president and CEO of the American Bankers Association, in a statement. "We hope the order will have its intended effect so that calmer and more rational markets for bank and bank holding company stocks will prevail."
While the short-selling ban is not viewed as a permanent solution to the problem, in the near term it should give relief to a financial sector that has been battered as the credit and housing crisis deteriorated, observers say. Short sellers made a market in placing bearish bets on financial institutions over the past year as the problems worsened in the sector and in some cases won out.
"I think maybe it gives a temporary reprieve," says Joe Saluzzi, co-head of equity trading at Themis Trading.
Morgan Stanley's stock has been under "considerable pressure" in recent days, writes Goldman Sachs analyst William Tanona. "Although some of the price declines may have been understandable given the issues at Lehman Brothers, Merrill Lynch and AIG, we believe most of the stock's downward spiral was exaggerated by short sellers."
Even with sweeping changes on the financial system, Morgan Stanley "should be well positioned to capitalize on future opportunities," Tanona writes. "We believe Morgan Stanley is sound as an ongoing entity."
UBS analysts, in a note on Friday, "can't help but wonder" if Merrill Lynch shareholders consider voting down the bank's deal with BofA.
"Maybe it's too late, but given wider collateral acceptance at the Fed and bank facilities, the potential
Resolution Trust Corp.
-like government solution for 'bad' assets and the ban on short-selling (could help capital raises), we think Merrill holders may be less interested in seeing this deal happen," the UBS note says.
Among bank stocks that were named on the list include those hit hard by the credit crisis including
, as well as Goldman and Morgan Stanley.
New York Attorney General
is also launching a probe into short selling in the financial market.
While the short-selling ban and government bailout plan for the bad bank debts are aiding financial stocks in the short term, in the long run, which companies survive will be determined by their individual challenges.
"On an institution by institution basis, each one has different problems. Washington Mutual is obviously different than Morgan Stanley. In WaMu's case it truly is a matter of how much bad debt they have in their portfolio," says Dave Grenier, president of Cutler Capital Management, which caters to high-net-worth individuals and oversees two hedge funds.
"Whether the stock price is at $2 or $3 it probably doesn't matter that much. What really matters is how much bad debt do they have and can they handle it staying independent?"