Bad Gyrations

Taming the Wild Stock Market

By Joel D. Joseph

During the past two years, and particularly during the past two months, the stock market has been exceptionally volatile, more like a Las Vegas casino than a business investment trading exchange. The Dow Jones Industrial Average goes up 300 points one day, down 200 the next. In 1966, the margin requirement was 70% and by 1969 the requirement was raised to 80%. The year 1966 was also when that the Beach Boys released their hit song “Good Vibrations.” I want to replace the Bad Gyrations of the stock market with the “Good Vibrations” of the 1960s.

It is a significant economic earthquake, a real tremor, when the stock market moves more than 5%, up or down, in one day. Since 1940 it has happened on average only once in every 734 trading sessions, or about once every three years. During the 1930s, it happened 95 times. Between 1940 and 1970, it only happened three times. During the entire decade of the 1960s, it happened only once. However, most importantly, the stock market has moved up or down by five percent in one day 15 times in the past two years. This is not a good thing, unless you think that the Depression of the 1930s was beneficial.

I have proposed four new rules to tame the bad gyrations of the stock market. These changes go to the core of the problem: leveraged purchases, day traders and speculators, gambling and derivatives.

The new rules are:

1. No buying on margin;

2. No short sales;

3. No commodity purchases by individuals or others not in the industry; and

4. No derivatives.

Margin: Investors can now purchase shares of stock with only 50% cash. After the Great Depression, the Federal Reserve was given the power to set the margin rate. But the Fed has not changed the 50% requirement since 1974.

When the market goes down and an investor’s equity goes below margin requirements, he or she gets a margin call. Investors get a nasty telephone call to bring more cash, or the broker is required to sell the investor’s stock. When the market is going down, margin calls keep the momentum going down by forcing many sales. We should increase the margin requirements gradually over several years to prevent market shocks.

short sales: Short sales are sales of stock that you don’t own. Investors can “borrow” another investor’s shares of stock, promising to buy them back at a later date. When an “investor” shorts a stock without borrowing someone else’s shares, it is called “naked” short selling. Short sales are quite simply gambling that a stock price, or the value of a currency or other investment, will drop. It is not an investment at all—it is gambling. Short selling exacerbates swings in the stock market. We should ban all short sales and send the speculators and gamblers to Las Vegas where they belong.

Commodities: Speculation in commodities, like oil futures, is rampant. You can purchase oil and other commodities with as little as 5% down. The recent swings in oil prices up to $140 and down to $30 a barrel were driven by speculators, not by supply and demand. We should limit sales of commodities to companies that supply or use the product traded. Under this new rule, oil could be traded by oil companies, airlines and others who use oil, not by speculators.

Derivatives: Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are contracts and can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region. Derivatives are pure gambling. Warren Buffett in 2003 called them, “financial weapons of mass destruction.”

Derivatives first appeared as over-the-counter contracts in 1991. Derivative speculation by insurer American International Group (AIG) was one cause of the Great Recession. The government bailed out AIG with $85 billion in loans. An AIG subsidiary had lost more than $18 billion over the preceding three quarters on credit default swaps it had written. These credit default swaps were issued to Goldman Sachs and others who invested in mortgage-backed securities. AIG insured these investments. Goldman was selling these securities short at the same time, hedging its bets. As a result of the bailout, Goldman pocketed billions of dollars in government money.

On Dec. 6, 1994, Orange County declared bankruptcy, from which it emerged in June, 1995. The county lost about $1.6 billion through derivatives trading.

The world economy lived well without derivatives and we can do so again. Similarly, short-selling, margin requirements and commodities trading can be regulated so that markets become investment trading systems, not casinos. When these new rules are implemented, the market should stabilize and we should have good vibrations once again.

Joel Joseph is chairman of the Made in the USA Foundation, a non-profit organization dedicated to promoting American-made products. Email joeldjoseph@gmail.com.

From The Progressive Populist, August 1, 2010