Moral hazard issues abound, but IMO this is the sort of market distress that government has an appropriate role. The new instrument to buy these distressed assets is a terrific idea and may wind up being a good investment for the US taxpayer (and US debt owner, yay them).

There was an interesting and helpful analysis of "what's been going on" in yesterday's NYT: http://freakonomics.blogs.nytimes.co...ial-upheavals/

Several things have been happening lately. As I think many know, most of this crisis rests with the housing market's sudden correction. Much of the debt associated with real estate was bundled into CDOs. I won't rehash the details of all of that. What is important to understand is the accounting principle of "mark to market". When a business assigns values to its assets, it can't just make up a number. It must base the assets' values on comparable assets in the market. Makes sense right?

Unless of course you happen to be sitting on top of a bunch of assets that are extremely distressed. These CDOs, everyone understands, are not worthless, and yet no-one is buying them right now because no-one understands the risk. Moody's and S&P told us forever that these were bomber-proof assets and we all know that's not true. But the mark-to-market is making these assets look close to worthless today, which is sorta like telling someone in Houston (where we had a hurricane last week) who put their house on the market two weeks ago that since no-one is making an offer they must assess the home's value at $0.

So these fin. institutions have been marking their assets to market and their balance sheets have been shrinking and this kicks in some contractual obligations they have with any short-term debt, since now the ratio of assets to debt has changed. Any of us who have borrowed know that it's easier to get money from a bank if you don't need it - i.e. you're camping out on a fat pile of cash with valuable assets and a good income
. If you really need the cash because your pile of cash has dwindled and your assets are gone and your "cash from operations" isn't looking so good right at the moment, then you're going to pay higher interest.

This has happened. The combination of the housing dip with the CDOs' risk being unknown has resulted in sky-high short-term debt costs for financial institutions sitting on these CDOs and unable to sell them. Look for FASB to establish new standards around the "mark-to-market" rules in place.

The second big issue is naked short-selling. Instead of writing up a long technical boring description of that, I suggest folks hop over to the wiki and hope the info there is basically accurate.

What I do want to point out is the math of naked short selling. Suppose that instead of leejo the extraordinarily good-looking, charming, and intelligent former fps player and current forum loudmouth, I were leejo the market maker. With me so far? OK now imagine that I'm interesting in the Bank of Fubar and want to open a long position on that business. As I buy shares, the price goes up, so opening my position and increasing my long position costs more and more leejo treasure to increase my position and my profit. This has an immediate cash impact, so leejo can only buy as many shares as available cash allows.

Contrast that with opening a short position. Suppose that I think that Bank of FUBAR now has the crosshairs on it and I want to short it as much as possible. When I open a short position, I create an obligation on my balance sheet (I owe someone X shares at some point in the future) and I receive cash from the proceeds of the sale. What's not to love? I get to keep the cash I have and even add to it. Since the market makers also happen to be these distressed financial institutions, it makes a lot of sense to preserve cash as much as possible and to execute trades that add to available cash - selling long positions and opening short positions.

One of the SEC's many roles in all of this is to determine and enforce when a short-seller must deliver the actual borrowed shares. The degree to which the window is small or large is basically a measure of how levered these trades can be. If I have to deliver the borrowed shares on the same day as the close of the trade, then it has the same cash impact as a long position and ensures that various market makers don't dogpile on a distressed business to generate fast, free cash. If I don't ever have to deliver the borrowed shares, then I could sell a million zillion shares of a stock when in reality only 250m shares exist. Obviously this dilutes the value of the actual shares!

All of this is to say that the SEC doesn't, I think, provide the illusion of protection. It does provide SOME protection. People who think it provides protection are equally mistaken, because in the markets there is only one person interested in you.