Jon Stewart does it again.

The SEC has recently come out with an emergency order to curb “naked short selling” of certain stocks (19 in all) that include Freddie Mac, Fannie Mae, Morgan Stanley, Goldman, Lehman, etc. The motivation is to alleviate the unrelenting short selling of these “vulnerable” stocks.

Currently, brokers and banks are not allowed to short sell without already having borrowed stock to cover the position. However, the precise terms of the timing of the “borrow” has been a little vague up until now. The new SEC order forces the short seller to formally borrow the stock before the short sell can occur.

This has all the major dealing houses scrambling to get these new controls in place before Monday. Additionally, it will make it more expensive to trade, and could impact the ability to trade options: traders often short-sell to hedge put option contracts they have sold. And if options traders can’t hedge themselves, they can’t sell put or buy call options.

One of the actual issues is that short sellers will often locate the stock to be borrowed on trade date, but not actually borrow it until settlement date (T+3). That can be problematic as multiple dealers can locate the same stock from the same source so when it comes to borrow, someone is left “naked”. The solution would therefore to secure the borrow on trade date, not settlement date.

Interesting Economist article on how the performance of the Yen indicates investor sentiment.

Ken Barnes of Wombat discusses NYSE’s Advanced Trading Solutions

Did you know that Bear Stearns has an entire energy business, Bear Energy ? Not just trading natural gas on the financial markets, etc, but actually OWNS a powerplant ! Its trading business therefore supports its physical energy business (by buying/selling natural gas to power their powerplant, and trading the power itself). The business is built on the back of Bear’s acquisition of Williams in 2006.

(Not an April Fool’s joke). “Swiss financial giant UBS has reported that its writedowns as a result of the sub-prime crisis have more than doubled to about $37bn (£18.5bn)”. Article here. I wonder how much more has yet to unwind.

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Nasdaq has released a new tool for replaying market data, viewing National Best Bid and Offer (NBBO) at any point in time and confirming best execution. The application is written with Adobe’s Air . We downloaded it and ran it: data can be recalled for a trading day down the the millisecond resolution for any symbol. Click on the image for more information from Nasdaq to give it a try. Also, screenshot from our download here.

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Interesting perspective from the Economist on the $7.2bn loss by a rogue trader at Societe Generale.

For $200m cash. Looks like the Wombat messaging platform will be integrated with NYSE’s TransactTools. NYSE press release here, Securities Industry News here.

Stephen Colbert covering Cramer’s outburst. Classic.

I see Bank Of America, JPMorgan and Citigroup have just announced a new $100 billion facility to help troubled Structured Investment Vehicles  (SIVs) by creating and providing liquidity support  in the market for asset-backed commercial paper and medium-term notes issued by these SIVs. The US Treasury is supporting the facility as it should help “foster orderly capital markets”

(Understatement) It really is not good when one of the major investment banks in Europe have to make announcements like this, stating that they are not able to value ABS-based securities due to “complete evaporation of liquidity in certain market segments of the US securitization market”. Scary.

When the markets took a knock last week, a few friends of mine were telling me that their companies made money by being long cash ….. novel idea.

I have been tracking the demise of the US housing market - the Economist has a good article today that discusses current events and mentions the Mortgage Lender’s Implode-O-Meter (!).

The recent Bear Stearns fiasco is only heightening the tension of an ever-increasing meltdown… Some of our clients have also been telling us about their concerns for their MBS, ABS and CDO pricing and trading businesses as the sub-prime market continues to cause derivatives effects in these structured securities.

I noticed that Moody’s Investor Services has *implied* that the credit ratings of Goldman Sachs, Merrill Lynch and Morgan Stanley were only two levels above “junk” based on the Credit Default Swap (CDS) market. Specifically, prices for credit-default swaps linked to the bonds of Goldman Sachs, Merrill and Morgan Stanley last week traded at levels that equate to debt ratings of Baa2.

This could be because CDS traders are more bearish than bond traders and have been more concerned about the slowdown in the housing (see blog posting) and global equity markets, and therefore Goldman & Co’s exposure to these markets through their massivley successful mortgage securitization businesses (which includes significant exposure to subprime mortgages).

The size of the CDS market is now an enormous $26 trillion (twice the annual economic output of the U.S.)!! According to Bloomberg, Goldman and Morgan Stanley have $171.6 billion and $168.5 billion respectively in bonds outstanding.

But what happens to their credit risk (and revenues) when these markets tank ? Since a Credit Default Swap is an insurance policy on a bond,  the buyer of the insurance pays a premium and gets a nice pay-off if the bond defaults. This is great for financial institutions in an environment of low corporate debt default rates.  Recently, interest-rate spreads above Treasuries on high-yield corporate debt were very low by historical standards. Some of this seemed ok since surging corporate profits have kept default rates on corporate debt very low. But since the credit quality of bond issuers has deteriorated in recent years, clearly the market has been out of sync with reality/history.

So, there are a few problems coming together here to potentially make a mess and really hit bank profits. If the housing market tanks and default rates increase, it is going to cost the banks a lot of money. During the recent sell-off, credit spreads have been widening and so the cost of insuring against corporate bond default (via CDS)  will continue to rise. And, if the actual ratings of these banks do drop to these implied ratings their borrowing costs will rise.