What Really Caused the Run on Bank Stocks (Hint: Not the Shorts) and a Rant on the Fed

Whenever things in the market start getting hammered, it's popular to blame the short sellers... Right now, in fact, there are even calls to ban short selling of banks because they're an easy target. That's ludicrous, of course, just as it proved to be after the Great Financial Crisis of 2008. The last thing anybody […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily] What Really Caused the Run on Bank Stocks (Hint: Not the Shorts) and a Rant on the Fed By Herb Greenberg --------------------------------------------------------------- [The EV Story No One's Telling]( Forget batteries, energy storage, charging stations, chips and everything else you’ve heard about electric vehicles... Because the biggest EV story everyone's missing is THIS. It's a brand-new asset that the International Monetary Fund claims should rise 24,900%. [Just click here now to find out how to stake YOUR claim in this secret asset today](. --------------------------------------------------------------- Whenever things in the market start getting hammered, it's popular to blame the short sellers... Right now, in fact, there are even calls to ban short selling of banks because they're an easy target. That's ludicrous, of course, just as it proved to be after the Great Financial Crisis of 2008. The last thing anybody should want, in a free market, is something that gets in the way of the market dynamics. Even Chris Cox, the head of the Securities and Exchange Commission ("SEC"), who originally approved the short-selling ban, told Congress at the time that it was a mistake. So, what was really causing bank stocks to get as hammered as they were last week... with the SPDR S&P Regional Banking Fund (KRE) losing roughly half its value since the Silicon Valley Bank failure? Harold Bradley has a theory, and it's not something anybody is talking about, even though it's hiding in plain sight... I first met Harold back in 2010 after the market had been rocked by the so-called "flash crash." I was working for CNBC, and he was chief investment officer of the Kauffman Foundation, a nonprofit known for funding entrepreneurs. While you may never have heard of Harold, one thing he knows a lot about is the mechanics of trading. As he puts it... My strongest experience on Wall Street was running a highly active buyside trading desk where we obsessively studied trading liquidity and became familiar with many methods for studying the market impact of very large institutional trades. In the wake of the flash crash, he and his colleague Robert Litan felt that ETFs posed systemic risks... that they risked becoming "the tail wagging the dog." As [I quoted him]( as saying at the time... My biggest concern is that we are treating ETFs as if they were securities, like they have an underlying company, rather than derivatives of underlying companies. He and Litan went on to [testify before the Senate]( that ETFs could be a triggering mechanism for market catastrophe. With the market going straight up, there was no catastrophe. And while Harold argues "there have been glimpses to prove our hypothesis on and off over the years," he now says... It took the Fed turning off the liquidity spigot to create the case study that deserves immediate and careful study. He's referring to what's happening right now with the regional banking ETF... As Harold explained in a writeup to his friends on LinkedIn, a lot of this boils down to human emotion clashing with market structure... The tragedy of the run on the banks has been the "price signaling" that investors believe stock prices contain. A portfolio manager emotionally responds to rapidly falling stock prices, often believing some information not known to the general public in expressed in the price. In a millisecond, traders buy puts on tens of thousands of shares of an ETF or on illiquid stocks inside an apparently easily traded ETF. Importantly, ETFs are widely used by financial planners and advisors, rather than individual stocks, for bets on such specialties as small biotechs, semiconductors and, yes, even regional banks. Harold goes on to say that in bear markets, stock volume usually falls, often fast. Here's where it gets interesting (and a bit technical, so stay with me)... In his LinkedIn post, Harold included a graph that showed the trailing 50-day average trading volume of his portfolio's largest holdings as a percent of the regional banking ETF. The 50-day average volume is a figure used by many traders to see what can be "expected liquidity" during recent "normal" times. As he explains... Our early AI work illustrated that more than 20% of trading volume in any day and more than three continuous days of "working" an order in the market could significantly affect the price both when buying and when selling a position. Of 27 of the largest positions in KRE, 16 indicated holdings significantly exceeded the 50-day average volume traded on February 28th. In other words, 16 of the top holdings in the ETF represented more than 100% of a day's trading volume. "To sell all of the volume in a short time frame," he says, "suggests major price dislocation." (In other words, prices collapsed.) What Harold is saying is that the very nature of the way ETFs buy and sell stocks could set off a panic... In this case, that means the needing to raise money by selling shares in stocks that might have had insufficient trading volume. Going into the panic trading volume in KRE's top five holdings (out of 145 stocks) had declined sharply. So, when news hit that regulators would make Silicon Valley Bank depositors whole, while wiping out stock and bond holders, "they extinguished one fire but started a stampede out of the theater," Harold says. That set off another chain of events, which he believes ultimately led to the run on the bank stocks... "Unable to evaluate the risk of positions," he says, "I believe financial planners jettisoned positions in financial ETFs." That, in turn, fed on itself, which gets back to the shorts: Rather than shorting the individual stocks, it's likelier that a greater number of speculative traders or anybody else wanting to short regional banks bought puts on KRE. After all, barring specific concerns about a specific bank, or merely shooting for the fences, that's the more sensible trade. Since then, especially as prices got clobbered over the past three weeks, volume in the regional bank stocks has more than doubled, "which is to be expected when prices are cut in half," Harold says. He adds... We may be witnessing a behavior caused by narrative fallacy where a run on the bank starts when the stock price drops – and the money flees with a few keystrokes – and hides down the street until that stock swoons. I hope that failure to govern ETF size respective to positions in common stocks held within portfolios hasn't led inadvertently to the collapse of banks that might have been able to raise capital. It's the ultimate moral hazard, I suppose. --------------------------------------------------------------- Recommended Link: [Whitney Tilson says buy these five stocks TODAY]( For a limited time, Wall Street legend Whitney Tilson is sharing the details on a situation he's been following for years. It's an opportunity to take advantage of an $87 trillion wave of wealth that has already started affecting the stock market. The good news is Whitney has handpicked his five favorite ways to play this situation. And he urges that you get in today. [Click here to see his analysis on these five stocks](. --------------------------------------------------------------- Moving on, through history short sellers have been convenient scapegoats for various of the market's ills... But let's not forget what caused the banking mess... While I strongly believe the Federal Reserve did the right thing by saving depositors in Silicon Valley Bank, the reality is, it never should have happened in the first place. Don't take my word for it. According to the Federal Reserve Bank of St. Louis' own website, in a piece titled ["In Plain English – Making Sense of the Federal Reserve"](... The Federal Reserve System was initially created to address these banking panics. It is now charged with several broader responsibilities, including fostering a sound banking system and a healthy economy. In other words, with three bank failures this year – totaling more than $500 billion, the most ever in a single year – the Fed failed. And it only has itself to blame, for bowing to lobbyists in 2018 and loosening regulatory restrictions and stress-testing on smaller banks. Irony of ironies, among those lobbying for the changes, were Silicon Valley Bank's parent, SVB Financial, and Signature Bank, which also failed... As The Hill [reported]( both "argued that they weren't a systemic risk to the economy, and thus shouldn't be subject to the same rules as the big banks." And the Fed bought it! When it comes to the Fed and the economy, most of us are novices. We assume they know what they're doing, and that it's not political, because it's not supposed to be. But apparently, they don't know what they're doing, it is political... and that's sad. For the sake of my kids and grandkids, please convince me I'm wrong by e-mailing me [right here](mailto:feedback@empirefinancialresearch.com?subject=Feedback%20for%20Herb). Finally, a quick heads up about this month's issue of my QUANT-X System, published last Friday... In it, I wrote about a 99-year-old financial services company that not only benefits from higher interest rates, but also from market volatility. Despite its age, the company believes it has only scratched the surface of its incredible potential market opportunity. The QUANT-X System helped unearth this hidden gem. Almost no one has even heard of this company. I know I hadn't! That's why the stock trades at a bargain-basement valuation... at least, for now. To learn how to get access to this brand-new research, [click here](. Regards, Herb Greenberg May 8, 2023 [Get a 60-day, 100% money-back trial to Empire Real Wealth by clicking here.]( --------------------------------------------------------------- If someone forwarded you this e-mail and you would like to be added to the Empire Financial Daily e-mail list to receive e-mails like this every weekday, simply [sign up here](. © 2023 Empire Financial Research. All rights reserved. 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