A new research paper suggests that the financial crisis of 2008 was preceded by suspicious market manipulation: a “bear raid” on Citibank’s stock in November 2007. The paper, written by scholars from the New England Complex Systems Institute, claims to have discovered intentional manipulation of Citibank’s stock price, which immediately followed the Security and Exchange Commission’s easing of certain regulations.

For those unfamiliar with the term “bear raid”, it is the action in which a massive short selling campaign is performed to drive a stock’s price downwards – guaranteeing a return. Short selling is the practice of borrowing stocks from a broker, selling them, and waiting for the stock’s price to drop to repurchase the same number of shares, returning these to the broker and pocketing the difference.

While traders typically short stocks when they believe the market will naturally bring the price lower allowing for short sellers to realize their gains, a “bear raid” attempts to drive the price lower by the sheer volume of short selling associated with the raid. Collaborative market manipulation drives the price downward, rather than collective negative outlook on the company.

The team of researchers found that Citibank’s stock experienced an unusual spike in short selling activity on November 1, 2007 — nearly four times the average daily volume. Six days later on November 7, 2007, a similarly high number of short positions were closed out after the Citibank stock had dropped $4.82 over the course of the week. If these short sellers were indeed working together, they would have earned $640 million on their ploy — a handsome sum.

The researchers believe this had to be a bear raid, because the likelihood that this happened by chance was virtually nil. Therefore, they argue, the SEC ought to reinstate the “uptick rule”: the old regulation that didn’t allow short sellers to contribute to a stock’s price decline by short selling. The SEC repealed the rule in July of 2007, just a few months before the bear raid.

The claim that this bear raid might have had something to do with the collapse of the financial markets nearly a year later is far-fetched, at best. But it does make a good case for better regulation of behaviors that can contribute to market volatility.

Read the paper here.

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