Blood in the Streets

Baron Rothschild, the quintessential banking opportunist, is said to have advised that the best time to buy is when there is "blood in the streets." To some, the first three days of this week indeed feels like blood is spilling on capitalism’s most famous avenue, that is, Wall Street. Yesterday felt like a replay of Monday, only without a big deal or a government loan announced.

Despite Treasury Secretary Paulson’s efforts to stave off a financial panic with an $85 billion rescue of AIG, stocks resumed their descent. The pain was spread across the board, with few places to hide for stock investors. The Dow ended near a three-year low, down 449.36 points, or 4.1%, at 10609.36, off 7.1% so far this week; the S&P 500 dropped 4.7% to 1156.39, down 7.6% for the week; the Nasdaq was down 4.9% at 2098.85, down 7.2% for the week; and the small-stock Russell 2000 fell 4.8% to 676.38.

The catalyst for the selling was fear, plain and simple. It started on Tuesday night, when the cost for borrowing skyrocketed, which put more pressure on investment banks, which need short-term funds to operate. The two remaining independent investment banks, Goldman Sachs and Morgan Stanley, led the selling spree. Specifically, unsubstantiated rumors were swirling around Morgan as speculation mounted that it would be the “next Lehman”. Both firms reported earnings that were in the black, and Morgan’s beat estimates handily, but that did not assuage nervous investors, who drove down MS shares by 24% and Goldman’s by 14% yesterday.

Both firms railed against short-sellers and the SEC finally listened and announced three actions addressing shorting. First, the SEC adopted a rule requiring short sellers and their broker-dealers to deliver securities by the settlement date (three days after the transaction date) and imposing penalties for failure to do so. In addition, the SEC eliminated the option market-maker exception to the three-day delivery requirement and finally, the SEC adopted a new anti-fraud provision making it unlawful for sellers to deceive specified persons about their ability or intention to deliver securities by the settlement date. Unfortunately, these measures come a little too late. As written in this column this year, the SEC should never have eliminated the Uptick Rule (which they did in the midst of a bull market!) and appears to be asleep at the switch when it comes to eliminating abusive short selling and rampant rumor mongering.

With that rant out of the way, what about that Baron Rothschild? Those investors who embrace his advice might be strong enough to turn a blind eye to the fear and panic gripping the markets and start dipping their toes in the murky investment waters. If you have a long time horizon, this could be a time to increase your retirement plan contributions or add a little extra each month to your investment account. Yes, it is difficult to do, but years from now, you just might look back and thank Baron Rothschild for turning you a bit more bullish at a time of maximum pessimism.