Tag Archives: great recession

Did a Bear Raid on Citigroup in 2007 Crash the Economy?

A paper (PDF) from a group called New England Complex Systems Institute seems to make the assertion that a "bear raid" on Citigroup in 2007 may have triggered the economic meltdown that led to the Great Recession:

A paper from the New England Complex Systems Institute claims that they have found evidence that traders executed a "bear raid" on Citigroup in 2007, precipitating the financial collapse. A "bear raid" is a market manipulation technique in which short sellers conspire to dump huge quantities of borrowed shares into the market all at once, driving the price down (short selling is a stock-trading technique in which shares are borrowed for sale; the short seller makes money when the value of the borrowed shares declines).

"Bear raids" have been considered a risk to markets since the Great Depression, and a financial regulation called the "uptick rule" was instituted in 1938 to prevent the tactic. The uptick rule was repealed in in July, 2007, and the alleged bear raid took place in November, 2007.

The paper's authors offered these comments about deregulation in their conclusions:

Within the resulting deregulated environment, it is still widely believed that the crisis was caused by mortgage-related financial instruments and credit conditions, and that individual traders did not play a role [32{35]. Our analysis demonstrates that manipulation may have played a key role. Methods for detecting manipulation and its eff ects are necessary to both inform and enforce policy.

When the SEC repealed the uptick rule on July 6, 2007, one of its main claims was that the market was transparent, and that such regulations were not needed to prevent market manipulation [6]. Our results suggest that, not long after the uptick rule was repealed, a bear raid may have occurred and remained undetected and unprosecuted. Our analysis reinforces claims that lax regulation was an integral part of the financial crisis [30].

In response to requests for reinstatement of the uptick rule after the fi nancial crash,the SEC underwent extended deliberations and fi nally implemented an alternative uptick rule, which allows a stock to fall by 10% in a single day before limitations on short selling apply [36]. This weaker rule would not have a ffected trading of Citigroup on November 1, 2007, as its minimum price was just 9% lower than the close on October 31. Subsequent day declines until November 7 were also smaller than 10%.

The authors go on to recommend some policy changes (adopting preventive measures instead of current retroactive penalties, regulatory agencies investigating individual events like this one, improve access to data, etc.) but given our government's reluctance to go after these folks I'm not confident that their advice will be heeded.

Don’t Just Blame the Banksters or the Bums

It's easy, convenient, a good story line, etc. to blame the Great Recession on a-hole investment bankers trying make a quick buck, or stupid home buyers who should have known better than to buy a $500,000 house on $45,000 a year in income, but it's also wrong.  As with most things in life it's complicated, and hopefully we'll start seeing more in-depth explanations for the financial meltdown as we move out of crisis mode and into recovery/finger-pointing mode.

I might have found a good place to start in today's Wall Street Journal.  Columnist David Wessel profiles the University of Chicago's Raghuram Rajan who has an upcoming book (July publication date) titled "Fault Lines: How Hidden Fractures Still Threaten the World Economy."  Based on the quotes that Wessel provides from his interview of Rajan it sounds like the book will look at the crisis from a big-picture angle, and while the usual suspects are identified as key players in the crisis they are also seen as role players and not arch villains.  I think that's an important distinction if we're going to learn anything from this crisis and fix whatever we need to fix if we're not going to completely torch the economy.

Anyway, here's my favorite quote from the column:

 "When easy money pushed by a deep pocketed government comes into contact with the profit motive of a sophisticated, amoral financial sector, a deep fault line develops," Mr. Rajan writes.