It's hard to follow from minute to minute what actually is happening, what is rumor, what is hope, what is sheer dementia. Apparently, the Fed and the Treasury have locked themselves in the panic room and decided to donate the United States to the banking industry. The government will take on all the toxic debt and radioactive derivatives that the financial names are sinking in like quicksand. It'll also guarantee money market funds, those ultra-safe investments, one of which just failed.
Of course, the government can't simply pay off the losses of the banks, savings and loans, and investment banks like Daddy writing a check. It is the biggest debtor of all, a Red Giant star of debt around which all the little overwhelmed institutions circle in orbit. So the Treasury rides in like the Cavalry, armed with two multi-megaton weapons: the power to borrow yet more money, and the power to print vaporware dollars. If you think your tires are inflated, just watch the U.S. currency — that'll show you inflation.
Bear markets proverbially end when the market "capitulates" — everyone decides it's hopeless and sells their investments, so there are no sellers left and nowhere to go but up. Not this time, though; this time it's the U.S. government that has capitulated, agreeing more or less to do anything the financial industry wants or needs.
That includes prohibiting short sales on almost 800 names. It's "temporary" until October 2, but can be extended. Supposedly this is to prevent speculation, which is claimed to be partly responsible for the recent carnage in the markets. I wouldn't know. For now, investors are taking it as a sign from heaven. In hoc signo vinces.
But like all forms of artificial share pumping, it has a potentially gut churning downside. Should the herd get spooked and run for cover again, there will be a huge vacuum under stock prices. With no short selling, in a decline there will be no one to buy to cover their short sales, which normally gives price drops some braking action. It would be ironic if today's madcap buying frenzy turned out to be the prelude to a crash.
It's rare that I link approvingly to the BBC, but I think this article sums up the situation well.
UPDATE 9/22: My mind was out to lunch when I wrote the next-to-last paragraph. Short sellers buy when the market goes up, not down, to cover their short positions. Still, disrupting the normal market mechanisms could have a downside: no short-covering rallies, therefore limiting the extent of share price gains.
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