No Uptick Rule: Convenient Scapegoat?

From the “you have only a few more days to kick me around” department: I’ve written here previously about the uptick rule and whether it is the cause of all that ills the financial world, er, the stock market.

I won’t sit here and argue whether it should be reinstated. The markets have clearly become more volatile, and some stocks, like Bear Stearns, have been obliterated.

But is the lack of an uptick rule to blame?

Several points:

1. There don’t appear to be any solid studies on the subject. Barry Ritholtz has a good chart here that shows volatility definitely has increased since the rule was fully eliminated in July of last year. Ironically, he points out, if shorts are fast to cover,the volatility would appear to be very much on the upside.

2. Many people forget that a pilot program on the elimination of the uptick rule went into effect on 1,000 highly liquid stocks in the summer of 2005. At the time, as Bespoke Investment Group points out, Jim Cramer, one of the most vocal proponents of reinstating the uptick rule and one of the truly very smart people I have known, wrote:

This rule change, of course, couldn’t come at a worse time. The market’s terrible. Longs are beleaguered, shorts are emboldened. I think it is fair to say that things are about to get a lot worse, a lot faster for the stocks of bad companies without the slowdown circuit breaker of the uptick rule. But the SEC, in its non-infinite wisdom, dreamed this little doozy up and all I can tell you is that you ain’t seen nothing yet.

As it turns out, the stocks of good (and bad) companies continued to enjoy the tail-end of the bull market, as stock prices rocketed for two more years.

3. While it would appear to have been a pile-on by shorts when the stock of Bear Stearns blew up, Bears Stearns was already a favorite short because of its high leverage.

4. If they were to reinstate the uptick rule, shouldn’t there be a downtick rule? Wouldn’t it help eliminate the stock melt-ups and bubbles? Oh, forgot: It’s okay if stocks go too high and investors who get caught up in the momentum get hurt; it’s not okay if the damage occurs with stocks going the other direction.

Reality: The markets probably ARE more volatile because of the lack of an uptick rule. But the volatility is likely exaggerated by the combination of the housing and related financial upheavals. The rapid decline of a stalwart like Bear Stearns has everybody looking for a scapegoat. The uptick rule would appear to be the most convenient.

Just remember, however: Even with the uptick rule gone, the free markets have prevailed and the markets have survived and, according to many bulls, are poised for a rosy future.

That’s my 2-cents for today. Agree? Disagree? Comment away.