Margin-of-Safety

The Nature of Wall Street Works Against Investors 40
Accordingly, market regulators have devised certain stock market rules that have the effect of
exacerbating the upward bias of Wall Streeters. First, many institutions, including all mutual
funds, are prohibited from selling stocks or bonds short. (A short sale involves selling borrowed
stocks or bonds; it is the opposite of the traditional investment strategy of buying a security,
otherwise known as going long.) Second, while there are no restrictions on buying a stock, the
short sale of exchange-listed stocks requires physically borrowing the desired number of shares
and then executing a sell order on an "uptick" (an upward price fluctuation) from the preceding
trade. 2 This can greatly limit investors' ability to execute short-sale transactions. The combination
of restrictive short-sale rules and the limited number of investors who are both willing and able to
accept the unlimited downside risk of short-selling increases the likelihood that security prices
may become overvalued. Short-sellers, who might otherwise step in to correct an overvaluation,
are few in number and significantly constrained. 3
After the October 1987 stock market crash several "circuit breakers" were introduced to
limit downward price swings on a given day. These included restrictions on the price movement
of slocks and index futures and on program trading. 4 The effect of circuit breakers ranges from a
temporary halt in futures trading to a complete market shutdown.
Two New York Stock Exchange circuit breakers apply only to market declines. If the Dow
Jones Industrial Average falls 250 points below the previous day's close, trading is stopped for one
hour. If stocks fall another 150 points after trading resumes, there will be an additional two-hour
halt. It is noteworthy that there is no similar provision regarding upward price movements,
regardless of magnitude. This is another example of how tjhe rules favor bulls over bears and
militate toward higher stock prices. Although high stock prices cannot be legislated (something
that many on Wall Street may secretly wish), regulation can cause overvaluation to persist by
making it easier to occur AND more difficult to correct. The upward bias of market regula-