Shorting Bank Stocks

This past week's introduction of new rules for shorting a selection of financial service stocks was evidently calculated to shore up confidence in institutions which are deemed by governmental and regulatory officials to constitute the necessary core of the US financial services system.

Several observations occurred to me as I read about the new regulations which took effect yesterday.

First, why were such loose applications of the already-extant rules regarding the borrowing of shares to short not simply enforced?

In a parallel to the recent introduction of criminal statutes focused on intent, e.g., 'hate' crimes, these new regulations seem superfluous. There were already perfectly adequate rules in effect, if only they were correctly and uniformly enforced.

Second, much as Truman invited the invasion of Korea when he drew the US security perimeter of the 1940s as excluding that country, the focus on a few financial institutions implies that the others don't matter to US financial system stability.

Doesn't this more or less declare open season on shorting those institutions not on the list?

Finally, does anyone really believe that a governmental propping up of presumed weak, or vulnerable financial institutions, will truly eliminate danger?

In finance, due to counterparty risk, perception of strength or weakness is far more important than actual strength or weakness.

Ringing the favored institutions with a special set of regulations designed to make it harder to easily short those equities in an illegal manner may safeguard their equity values, but, surely, investors also realize that it also will tend to prevent true price discovery in a significantly downward fashion.

It's an interesting question, though. Did illegal shorting contribute to Bear Stearns' downfall? Will prohibiting such illegal over-borrowing of shares to short merely bring correct price discovery back? Or will it actually inhibit price discovery?

It seems like another reason, in my opinion, to steer clear of most financial sector equities for a while longer. There just seem to be too many 'special' situations and allowances being made for them at present.

What the real value of a mediocre US financial utility is in the long run is anybody's guess now. So many questions exist regarding Fed window access, equity market regulations, and mark-to-market rules, that it just seems too risky to hold them when plenty of other opportunities exist in equities and derivatives in which to invest and outperform the S&P500 Index.