So in the New Financial Order all the blame is being piled at the
feet of people like "speculators" and "hedge
funds" for short selling, there is nothing wrong with these
financial institutions, they are just being mugged.
When a young woman dresses in next to nothing and then proceeds
to drink herself into oblivion we are told that the next day it
is wrong for us to say "she brought it on herself" when
she reports being raped, and yet that is what many feel, we tend
to reserve our anger for those who victimise modestly dressed
young women who have had only a glass or two of wine.
Short sellers are not rapists, or muggers, they aren't taking
anything by force, and they are doing anything different from the
man walking into the bookmakers or a casino and placing a bet.
If Perens Widgets is trading at 100 bucks a share "short
selling" is placing a sell at 80 and a buy at 60.
If I'm naked shorting I don't need to own the stocks in
the first place, so in effect I am placing a bet that Perens
Widgets is going to drop to 60.
If the gamble works out as planned, I make 20 per share.
If it doesn't work out as planned I could find myself
if naked shorting, having to deliver shares that I do not
own and must now buy at whatever the market rate is, could be
110 a share.
if regular shorting, selling shares at 80 that are now
worth 110
Unlike the mugger, and like the gambler in the bookies and
casino, I can get wiped out financially, at which point I can no
longer play.
There is however one good side to shorting a stock, you cannot
get left holding a wad of stock that you bought at 60, and watch
it drop to zero, because in effect you sold it before you bought
it.
In real life if Perens Widgets were trading at 100 and I shorted
a sell at 80 and a buy at 60 I'd go broke at the Roulette
Wheel, fast. What actually happens is I sell at 99.95 and buy at
99.90, and just like the Roulette Wheel lots of player just sit
there placing bet after bet.
But it still comes to naught but personal bankruptcy if we short
anything that isn't going downhill, this is where we sort of
come back to the mugging and rape, if you do not pass out in an
alcoholic oblivion on the wrong side of the tracks at 1 am decked
out in Rolex and Gold lame iPod, you don't get preyed upon.
Sure, rape and mugging and indeed gambling are still wrong, but
your status as victim is always dramatically weakened if people
can point the finger and somehow accuse you of in effect inviting
it to happen.
Yeah, you can be out partying on the wrong side of the tracks at
1 am and come to no harm, (I was a bit of a specialist at this
myself) but the pre-requisite is keeping your street smarts with
you at the door. I used to go places (abroad) that literally had
blood on the floor and bullet holes in the walls, but I could
handle my beer, didn't have an attitude and was wearing
mechanics overalls after a hard day at work, mainly you
didn't hear my mouth over all the others.
The Halifax used to be a Building
Society, if not the biggest in the UK them damn close, and
all it was was a building society, but then in the nineties the
Halifax, along with many others, decided it didn't want to be
a building society any more, it wanted to be a Bank.
So it threw off the staid boring old tweed jacket and put its
party clothes on and started carousing into the wee hours in
places it wouldn't have been seen dead in before, and to
those of us sat in the corner wearing overalls and quietly
supping our beer away from the spotlight of professional life it
was both an intrusion and also a foregone conclusion that it was
only a question of time before someone decided to stomp on their
face.
As much as we would like to place the blame for Halifax (and
everyone else) tanking at the hands of the uncouth short sellers,
the fact is that if Halifax had been prudent and stayed as a
building society then this would never have happened, could never
have happened.
SO now there is much hand wringing, oh dearie me, how can we
apportion blame equitably?
As the old joke went, it is like playing pass the parcel (the
parcel being a ticking bomb) in an Irish pub, all very well
blaming the one holding the parcel when the music stopped, but
the very act of playing was what decided your fate.
In my experience if you meet an incompetent employee, and then
another one, in the same company, then inevitably the rot goes
all the way to the top.
What we see here is the same thing, the Gordon Gekko
greed is good mentality was prevalent throughout these
institutions, from the fat cats at the top all the way down to
the clerks at the bottom.
So where will it all end?
The USA has, astonishingly, effectively nationalised AIG by
pumping 85 billion dollars into it, and the market response? AIG
shares fell a further 22%, which was admittedly probably a whole
lot "better" than what would have happened if left to
themselves and simply collapsed.
However, closing the casino doesn't eradicate the gamblers or
their culture, and this is the real issue here.
Fear is stalking the streets of the financial markets, and this
is because closing one game or even casino in Las Vegas just
means the punters will go elsewhere, Las Vegas takes a long time
to contruct and to gain momentum, and once that momentum is built
you can't just turn it off like a tap.
Well, you *can*, but nobody really has the guts to either
bulldoze Las Vegas or Wall St in toto.
So now the gamblers are eyeing up the remaining tables in the
casino, Washington Mutual, Wachovia, Bank of America, Morgan
Stanley and Citibank for starters, and just like the Halifax and
the teen on the wrong side of the tracks, they put themselves
there, by choice, by free will, contrary to the warning voices,
in the first place.
Now, like the tale of the frog and
the scorpion, the shorters are going to continue to sting the
frog half way across the river, and the only ones
"immune" from their attentions are those who decided
that discretion was the better part of valour, and maybe partying
till the wee hours on the wrong side of the tracks wasn't
really the best idea.
Make no mistake, this is the financial equivalent of the cuban
missile crisis, we could well come out the other side, reasonably
intact, on the other hand the global financial system could be
changed forever, except this time the "us and them"
isn't west vs east, it is casinos vs gamblers.
Lloyds bought Halifax because Halifax was starting to see a
run on the
bank, and it is impossible at this stage to say whether or
not Lloyds has merely delayed the inevitable and also sealed its
own fate this way. The new Lloyds Halifax simply is not "too
big to fail" from the actual real monetary perspective,
nothing is.
The only "crisis" in the financial sector is a crisis
in confidence, and this crisis in confidence is what gives the
short sellers their arena to operate in.
You cannot "fix" this along as there any roulette
wheels open anywhere on the strip, they will attract all the
remaining gamblers, and you cannot "fix" this unless
you first accept the the problem all came from things like the
Halifax deciding to become a Bank in the name of greed.
Rebuilding confidence in our financial institutions is the cure.
"how" that is done is the proverbial (in this case) 64
billion dollar question.
with bailouts we are causing lost confidence in the backings of
the currency itself, there could well be, for example, a
"run" on the U.S. government / federal reserve, with
nations dumping the securities backing the dollar. The results
would be really catastrophic compared to letting AIG fall.
Bailouts don't solve core problems. They merely
postpone dealing with problems, but at the same time let the
problems grow. The bad debt companies like AIG hold are
still there, and moreover bailouts saddle the government and
taxpayers with yet more debt, at interest.
Sacrificing the future on the altar of the immediate.
To restore confidence in the currency, we'd have to let these
institutions holding bad debt fail and fall flat on their face,
let them reap their just rewards.
64 billion, nope, over 900 billion thus far just for the U.S.
federal reserve and treasury, sure mostly as loans but will they
be paid?
Except the foreign banks are
propping up the U.S. at a fantastic rate. The creditors
of the U.S. -- foreign governments, banks and investors -- are
the only on that can start a run, and they aren't going to
let that happen.
So far, we're talking the Bank of Japan, Bank of Canada,
European Central Bank, Bank of England, Bank of Switzerland, and
many others.
I wonder if there is going to be anything left of this country
that is owned BY this country.
They won't let it happen? they may be powerless to stop
it. to assume they will continue to prop up the dollar
after massive dumping by a large holder, say China, may be very
foolish. to assume they will continue to do so if the
interest payments on the national debt (which was described as
'skyrocketing' well before this year) outpace the ability
of tax revenue to pay it, may be very foolish.
Well, I can't envision any of them
intentionally stepping back and saying "fuck
'em". I can see them all trying their best to pump
dollars into the system but failing, but it won't be from
lack of trying.
Though, to put things in perspective, the DJIA dropped about 4%
yesterday and about 4% Monday. Tuesday was a rise, but not
very big.
In contrast, on October 19th,
1987 the DJIA dropped 22.6% in one day. That was larger
than the Great Crash of 1929, which took place over a 3-day
period.
It brings into question the validity of using just the
DJIA as a measure of economic health. People love numbers,
and watching dramatic rises and falls of the DJIA and other
international indexes is entertaining, but there is more to
economic well being than just the stock market.
I think you have the distinction between naked and normal short
selling not quite right.
With normal shorts you simultaneously enter a collateralized debt
contract with your brokerage house to borrow some stock they have
sitting on a shelf and you immediately sell that stock.
Your other deposits with the brokerage house are your collateral.
If you bet wrong and the stock you sold starts to go up in
price too far, the brokerage can say "Ok, enough is enough.
Sell your collateral, buy up some of that stock, and pay your
debt NOW."
With a naked short you tell your brokerage "Ok, make a
contract with that buyer over there and tell him I'll get him
stock X at today's price in 3 days or less." If you bet
wrong and the price goes up too much, then at the end of 3 days
you tell your broker "Oh, sorry -- couldn't come up with
it. Please cancel that sale." In turn, the broker turns to
the guy who thought he bought X from you and says "Gee,
sorry, that one fell through. Would you like to place a different
order?"
The argument against naked shorting is that large, naked, short
sales at what is today a slight bargain price show up on the
ticker price of the stock. The rest of the market notices
"Oh, that stock is dipping in price. Something must be wrong
with it." Some of them will then try to dump the stock,
lowering the price further. If the price indeed goes down even
more in less than 3 days, you buy at the lower price, deliver the
shares of X you promised, and make a profit. Yet, what has
happened? The market "decided" that X was going down in
value only because you bet that it would and worse you
don't even have to make good on your bet!. It's as if
you walked on to the trading floor and started repeated "X
sucks!" so much and so loudly that people finally started to
believe you and that makes it a self-fullfilling prophecy.
Normal shorting makes a lot of sense. A brokerage is always
sitting on a large inventory of stocks. While they sit there,
they aren't doing anyone any good. Normal shorting is a
relatively safe way to let the market decide how to try to make
interest on those shelves of stocks. The brokerage always has
roughly enough on hand in some mix of stocks to quickly
give all of its customers exactly the stocks each one owns
but the mix the brokerage has on hand isn't literally
the exact mix of stocks customers have on deposit. Sorting
let's people "change the mix" in safe ways such
that the "proper" mix is always easy to restore if need
be but, otherwise, there might be extra profit coming in, split
between the brokerage, the short seller, and perhaps the owner of
the borrowed shares.
Naked shorting just throws in a lot of "flaky" sales --
sales that might be canceled in 3 days at the seller's
discretion. "Hey, those guys are saying they can come up
with 1,000 shares of X at $Y in three days, just sign here and
pay on delivery. Do we trust 'em?" only whenever
convenient, delivery never happens and you just tear up your
little contract. And meanwhile, other people look at that and say
"Only $Y? Gee, I better dump my X even if I only get
$Y-1!" -- and suddenly, the short seller has what he needs.
"Technical" trading strategies, for anything other than
conservatively and safely trying to make extra margins, are the
root problem. I mean technical strategies in contrast to
long-term fundamentals-based investing based on values of
tangible assets and anticipated dividends.
When there is too much technical trading, price signals in the
market (such as the announcement of a large, naked short sale)
get taken too seriously. People aren't buying and selling X
because they've looked long and hard at what X owns and how
X's margins look but rather because they think they see
pretty patterns in the charts and graphs of X's price, other
stock prices, and a few high level accounting numbers about X.
Here's the thing: "You may ask yourself, how did I here?
You make ask yourself, how do I work this thing?" And the
answer should hit close to home around Technocrat. Pogo was
right... we have met the enemy....
!970s onward, really exploding big time from the 1980s onward
there was a big, big niche for a certain breed of Computer
Science grad student: put on a suit, learn some AI and some
systems programming and get some milspec software engineering
chops -- then put on a suit and move to an expensive apartment
near a financial district. Join a start-up or a big house. Make a
steady salary with good benefits hand over fist (but long hours
and very, very serious work environment -- none of that
namby-pamby silicon valley take the afternoon off to see the
Grateful Dead and go to tomorrow's project meeting still half
tripping stuff.) Earn your keep by inventing an escalating war of
computer-managed technical trading.
Those CS types all went to various companies and thus were
competing against one another. They played the financial markets
like it was a game of CoreWars.
Remember the brokerage houses -- sitting on large inventories of
deposited stocks. They like to "change the mix" of what
they hold, ideally always hold enough to make good on deposits
but ideally also holding a better mix. And so the rules
leave all kinds of room for that. The programmers took
exploitation of those rules to whole new levels, never
anticipated by the rule makers (and not easy to make rules
against, anyway).
For a while, everyone was a winner. Central banks responded with
more cash for why shouldn't they keep loaning out more
so long as most everyone is turning a profit and consumer
inflation isn't too bad!
Most of that extra cash went into.... more technical
trading. More work for programmers. More data centers.
Fancier algorithms. More abstract derivatives.
Inflation did hit hard. It hit stock prices.
So you start getting pockets of "illiquidity":
Brokerage X is holding a gazillion shares of stock Y. On their
books, and even at current prices, Y is valued at $Z. One small
problem: $Z is so high that very few sales are taking place --
nobody is buying. If X wants to dump Y they are in a bind because
their large offer to sell will drive the price way down below $Z.
So what? Well, if Y goes way below $Z then suddenly the
brokerage's actual mix of stocks owned is nowhere near
enough to make good on deposits.
This doesn't mean that shareholders will go to brokers and
say "I'd like those 10 shares I deposited with you,
please" and be turned away. The rules are tight enough to
prevent *that*. However, investment funds of various sorts
take the hit. For, with a fund, share-holders (in the fund) have
given up all pretense of having their own personal mix of stocks
on deposit -- they just have shares of the fund and the fund
consists of whatever the fund manager decides. So if the fund
manager blows it and his current mix of paper suddenly falls way
below what fund shareholders are expecting -- well, tough beans
for those fund shareholders. The problem spirals when shares of
one fund of this kind are the "stock Y" in the mix of
some other fund.
Technical trading built up a spiraling inflation of securities
values. Technical trading created the modern investment fund
industry which grew on the margins of that spiriling inflation of
securities values. On paper, this looked like the brokerages and
funds were reeling in profit and they were able to take on a lot
of debt (to have more capital to use to further inflate their
holdings).
Securities prices got so high that buyers disappeared from some
of the hardest hit segments. Funds are collapsing in value. They
aren't good for their debt. "Game over."
You might say: "This is not my beautiful house!" You
might say "This is not by beautiful wife!" Technical
trading created the bubble in some securities that cheapened the
price of central bank cash that further inflated the bubble and
caused a bubble in borrowing that further inflated the
inflationary bubble until there was a lot of borrowing and nobody
left to buy these very highly priced securities that were backing
the debt that is now... "poof".
And it's all because Hacker Adam had a good calculus teacher
and liked the Manhattan lifestyle and Hacker Ben got a thesis out
of some interesting signal-processing/AI work and had connections
in Boston... and....
I don't see Mr. Buffet sweating all that much.
But, basically: "we" did it.
The "new order" will hopefully be something that tries
to recognize this failure mode however it should be noted that it
is just about impossible to "regulate away."
"Letting the days go by/let the water hold me down
Letting the days go by/water flowing underground
Into the blue again/after the moneys gone
Once in a lifetime/water flowing underground.
"Same as it ever was...same as it ever was...same as it
ever was...
Same as it ever was...same as it ever was...same as it ever
was...
Same as it ever was...same as it ever was..." -- Once in a
Lifetime, Talking Heads
Most of that extra cash went into....more technical
trading. [ ... ] More abstract derivatives.
I agree with your comments and the Talking Heads references. And
I also agree, it's next to impossible to regulate the trading
activity ...
BUT ....
You also dashed off a statement that goes to the root of many
discussions .... what can be regulated is the
"more abstract derivatives". Assuming all the
trading models are doing the work, it becomes harder and harder
to assess the risk of the ever more exotic derivatives. And, of
course, we have the derivatives of the derivatives, etc., etc.
I am trying to find the comment from back in July where it was
stated that the exposure of any given derivative (the context was
CDOs) has become next to impossible. If you can't assess the
risk of an investment, why would you invest in it?
I think if you did that people would just evade the regulation.
For example, people would reconstruct the system using something
like Linden
dollars, out of the reach of regulators.
But, yeah, why do people buy them when they're so crazy? I
suppose that if your competitor is acting crazy that way
and making a lot more profit than you, you feel like you
don't have a lot of choice....
Heh. The entire history of market regulation is one of
evade-regulate-evade, ad nauseum. The mentality of
"well, if I twist it in this direction, I can get away with
X" is sad, but pervasive.
With a naked short you tell your brokerage "Ok, make a
contract with that buyer over there and tell him I'll get
him stock X at today's price in 3 days or less." If
you bet wrong and the price goes up too much, then at the end
of 3 days you tell your broker "Oh, sorry -- couldn't
come up with it. Please cancel that sale." In turn, the
broker turns to the guy who thought he bought X from you and
says "Gee, sorry, that one fell through. Would you like to
place a different order?"
That doesn't jibe with my understanding of naked shorts.
Typically, you can't just back out because it didn't work
out for you. You're on the hook for providing those shares,
and you're obligated to buy them at whatever price you
can. Your brokerage will liquidate your entire account if you
can't pay up. That's what makes shorting so risky--
there's an unlimited downside.
To be even more careful, in 2005 the SEC made the additional
requirement that the dealer must
identify the stock being sold to guarantee that the inventory
is available.
Note: I don't do short selling or anything like it, but I
know some sophisticated investors who are pretty familiar with
it.
Yr mistaken (David) I'm pretty darn sure. I'd like an
objective, "here's the proof" correction if I'm
wrong but I don't think I am.
You're "on the hook" and you're assets will be
liquidated for a normal short sale. You can stay on that
hook for as long as the broker (your creditor) thinks you are
good for it (and what passes as "good for it" is
tightly regulated).
But there's a rule about all trades: they can fail
within 3 days in "no fault" ways. Here's a
rant about it. A naked short has the seller taking advantage
of that no-fault transaction failure loophole. People say
"Sure, I can sell you X share of Y at $Z..." when they
have neither
bought or borrowed those shares and, if 3 days later they
don't see how to make good, they basically just say
"Oops, sorry. Nevermind." Meanwhile, the ticker price
of the stock reflected the purported sale for 3 days.
I talked to someone I know who's an expert in these sorts of
things. First of all, the CEO of Overstock.com apparently has
something of a reputation as a
crank and conspiracy theorist. In the rant you mention, he
charges that the SEC isn't enforcing its rules. Be that as it
may, here's how short selling works (or is supposed to, under
SEC rules.)
First of all, naked shorts are not, and never have been, exactly
legal. But there have been a variety of loopholes which make them
possible.
There are three phases of a short sell. One is locating the stock
to be sold, the next is making the trade, and the third is
settling the trade (i.e. delivering the goods.) And they are
required to occur in that order. Naked shorting involves skirting
the locate requirement.
For individual investors, your broker takes care of locating the
stock, since far too many individuals don't know what
they're doing and brokers don't trust them. Locating
involves identifying the specific stock which will be borrowed
long enough to settle the trade.
Institutional investors are allowed to do their own locating.
Pre-2005, they didn't actually have to secure the
stock, that is get an actual agreement to borrow the stock, they
just had to have an informal agreement. So you (as an
institutional investor) call broker A and ask if he has a million
shares of IBM you can borrow in three days. Then you call broker
B and tell him that A is lending you the shares. But it's
possible for A to then sell the shares and leave you in the cold.
According to a temporary rule passed this summer, even that
isn't possible for 19 particular institutional investors: the
stock must be in your possession when you make the trade.
As for being able to cancel ("unwind") a trade, that is
possible, but it's a painful process. It's literally
called rolling back the tape. (As in the stock ticker.) They go
into the database and undo not just that trade but all the trades
that were dependent on it, then try to patch things back up as
best they can.
First of all, naked shorts are not, and never have been,
exactly legal. But there have been a variety of loopholes which
make them possible.
There are two common conceptions of "legal".
There's "spirit of the law" and there's
"if you can't get caught at it by perfect enforcement of
the rules then it's legal.".
That second sense about "even perfect enforcement can't
nail that" is where the supreme court found the famous
"right to privacy". It's an important sense of
legal. Naked shorting violates the spirit but not the letter of
the law and enforcement, even if perfect, can't eradicate it
(not because of a "privacy right" this time but because
of the necessary ambiguities in the accounting practices).
So, yes, it's not exactly "legal" in every sense
and yet the law produces no remedy for some forms of it.
Naked shorting involves skirting the locate requirement.
And that's a perspective on it that I didn't get until
Charles brought it up in other comments in this thread. It's
a very interesting observation.
As for being able to cancel ("unwind") a trade,
that is possible, but it's a painful process. It's
literally called rolling back the tape. (As in the stock
ticker.) They go into the database and undo not just that trade
but all the trades that were dependent on it, then try to patch
things back up as best they can.
It's not as painful for an institution that is engineered to
be able to do that regularly, efficiently. It's just
paperwork. Spreads pain in the market, sure -- but not
necessarily causes much pain for the naked shorter. That's
what people are bitching about.
They can bitch all they like though, to an extent, because T+3
(without actual escrow) guarantees that there will be
naked shorters and people depend on T+3 for other reasons.
Naked shorting involves skirting the locate
requirement.
And that's a perspective on it that I didn't get
until Charles brought it up in other comments in this thread.
It's a very interesting observation.
It also allows the 'market' to be more efficient.
If you believe that a stock in undervalued it is pretty trivial
to buy it. Other's will probably also share your view and
soon the stock price will reach 'market value'. In many
cases you don't even have to front the money, your broker
will let you buy it on credit.
If you think a stock is overvalued you must go through the whole
song and dance described elsewhere so not only will it take
longer for the stock to reach its 'market price' but
there is also an added transaction cost on top of this of having
to locate the stock.
If the shorters push the price down too low then case one takes
over, 'speculators' push it too high then case two.
Ignoring the whole dying company having it's stock shorted
out of existence strawman that I believe the guy from Amazon was
whining about a while back.
The real question is if the restriction on naked shorts benefits
the overvalued company or protects the investors from
'manipulation'? I think it's safe to assume in the
case of the 19 protected banks the interests of the investors
took second place to the interests of company and the banking
cartel as a whole.
I'm kind of wondering what they'll do when the Fed goes
bankrupt, too bad you can't short their stock.
So, another possible solution would be to change the
ticker and instead of reporting a single price report two:
one for settled transactions and the other for outstanding
transactions. In other words, instead of banning naked shorting,
embrace it but make it stochastically transparent. The
uncertainty in the current ticker prices would at least be
quantified and broadcast in an objective way.
It's not as painful for an institution that is
engineered to be able to do that regularly, efficiently.
It's just paperwork. Spreads pain in the market, sure --
but not necessarily causes much pain for the naked shorter.
That's what people are bitching about.
The database may be set up to allow it, but believe me, it's
painful. Like I said, it's not just the short sale that's
involved. If I buy a stock at a particular price, obtain
possession of it, and then a day later my broker says the sale
was canceled retroactively, what do I do? I'm not going to
give that stock back. The sale was final, the law says it's
mine.
What happens is that the brokers unwinding the trade goes out and
buys stock identical to mine and gives it to me to cover the
difference. Point being, somebody pays for it. It's
not just diluted across the market; fingers are pointed at the
guilty party, and that's who pays the tab.
As for waiting a day or two before unwinding a transaction,
that's like if someone spent a bunch of counterfeit $20 bills
and you had to undo and repair all the financial transactions
those bills touched after they'd passed hands a couple
hundred times. With computers it can be done, but it's messy,
and in the end someone has to pay the bill. And some transactions
simply can't be undone, such as when a rare (illiquid) item
changes hands.
Now if you want to believe Mr. Byrne, in an environment where the
SEC keeps tightening regulations on short selling (as of today,
all short selling of financial institutions have been banned),
certain traders are being allowed to short Overstock.com (T+3 as
you call it) and then undo their trades after a few days. And,
Mr. Byrne argues that they are being allowed to get away with
it-- that is to say, someone covers their losses for them.
Now, it is the case that a broker will often cut a deal for a
good client. But if a broker wanted to let a bad short slide, it
would be easier just to give the client the money straight up
than to undo the transaction.
According to Mr. Byrne, the brokers are cutting certain big
investors a really good deal, eating the difference without
complaint, and the SEC is letting it slide. All with the effect
that Overstock.com has a low stock price. And that the stock
price isn't low simply because Overstock.com still isn't
profitable. That isn't outside the realm of possibility
during good times, but in these days when even the banks are cash
starved, it strains credulity to say the least.
Keep in mind, this is all unrelated to the general question of
whether short selling has been creating turmoil overall in the
market. Naked or not, short sales do increase the level of
volatility since they are the essence of trading for the sake of
trading. That and they force transactions to occur based on
3-day-old information. But it's not clear how much of an
impact they actually have compared to normal selling. And right
now an institutional investor would be crazy to do much short
selling: the entire market is cash starved, the high-risk
investors have been trying to unwind their leveraged investments
(not their transactions!) for months to avoid being the next Bear
Stearns.
(Keep in mind: Bear Stearns was "bailed out" in the
sense that it was sold at a third of its value a few days before,
and about 1% of its value a year before. Its board and management
didn't loose everything: just their jobs and 99% of their
assets. JP Morgan was the big winner, and it was rewarded for its
lack of risky investments.)
The real issue in this current crisis is the illiquid securities
that the big boys were dealing in. Company A (e.g. Bear Stearns)
invests in a novel kind of contract. Say for example A agrees to
insure your mortgage: if your bank fails in the next 10 years,
they'll take over the mortgage. (Investment banks can't
really sell insurance, but they can skirt the law by not
technically making it insurance.) Then they decide that your bank
is too risky, so they want to back out. But they can't just
un-write the contract, so they sell a similar contract to Company
B. It doesn't undo their investment, it simply
counter-balances it. The big investment banks have been going
back and forth with these sorts of deals for years. It has
created a huge tangle of interdependencies that can't be
undone. That's why Bear Stearns couldn't be allowed to go
bankrupt.
AIG, on the other hand, couldn't go bankrupt because it was
involved in insuring mortgage-backed securities we've heard
so much about. And those have become illiquid simply because
nobody wants to buy them anymore. So we have the Fed trying to
stave off disaster while the market figures out what these
mortgage-backed securities are worth (that is, people start
buying them at any price). The balance the Fed is trying to
strike is to keep the world economy moving while not allowing the
bad boys to make a profit. In the process, however, the federal
government is ending up owning a whole lot of insurance policies
on a whole lot of home mortgages to people with bad credit
ratings who made no down payment and were never able to afford
their monthly payments.
I'll bring the whole thing down to one word,
"gambling." We're told that the markets are
for "investment," but it sure seems as if 90%+ of
what's going on there is "gambling," plain and
simple.
I wish they'd go to the tracks, instead. That's
where gambling is supposed to happen. The markets would be
better if it stayed investment, because if gambling happens there
it can have repercussions in the real world. It's
entirely possible for Company A to be planning and executing, and
doing everything correctly, but because of bad actions by Company
B in a related industry, the gamblers can tank Company A's
stock price and credit rating, and thus its business future.
IMHO one major problem with the increased wealth gap in the US is
that it made too much "invesment money"
available. Gamblers then ran hither and fro with this
money, and it was in such large amounts that it distorted the
very markets they were "investing" in. Oops -
that market failed, let's go find another place to gamble,
and destroy it, too.
With "regular" shorting you don't necessarily
"own" the stocks either, and unless you are hedging a
long position in the same stock, you typically don't. Regular
shorting involves you borrowing the stocks from your
broker/dealer, not owning them. Your broker/dealer needs to own
them, not you.
I don't know why you keep posting financial articles. As seen
in your last one, you have, at best, a very rudimentary
understanding of it. At worst your understanding is not even
accurate. But I guess you're older than some of us and hence
know so much more, right?
With normal shorting you do own the stocks and when you
sell them that sale is final. You had the right to sell. You did.
The buyer actually gets them.
The key thing is that with normal shorting you also take on the
same amount of debt, to your broker, and that debt has to be
(essentially) fully collateralized and if confidence in
your collateral starts to erode your loan can be called in
immediately, your own other stuff gets sold, and your debt paid.
"Naked shorting" is when you don't take on a
collateralized debt but instead form a contract to sell something
you don't own, within three days, with a free pass if you
fail to honor the contract (though you don't get paid in that
case either). After making a "naked short" sale you
then go out and try to buy the stock you need to fulfill
the contract. If you can't find it at a price low enough to
make a profit, your free out let's you just cancel the sale.
But, meanwhile, for 3 days, on the board -- all that shows up is
that you sold stock at the price of your contract (even though
that's not certainly true). People react to the price change
on the board as if it were real and meaningful, often in ways
that drive the price down further but with real trades.
Taking advantage of that, you can buy your bargain stock and
complete your contract.
There's no penalty for failing to fulfill a naked short
because the right to cancel the contract is built in to the
system as a safeguard for all kinds
Short Circuit
So in the New Financial Order all the blame is being piled at the feet of people like "speculators" and "hedge funds" for short selling, there is nothing wrong with these financial institutions, they are just being mugged.
When a young woman dresses in next to nothing and then proceeds to drink herself into oblivion we are told that the next day it is wrong for us to say "she brought it on herself" when she reports being raped, and yet that is what many feel, we tend to reserve our anger for those who victimise modestly dressed young women who have had only a glass or two of wine.
Short sellers are not rapists, or muggers, they aren't taking anything by force, and they are doing anything different from the man walking into the bookmakers or a casino and placing a bet.
If Perens Widgets is trading at 100 bucks a share "short selling" is placing a sell at 80 and a buy at 60.
If I'm naked shorting I don't need to own the stocks in the first place, so in effect I am placing a bet that Perens Widgets is going to drop to 60.
Unlike the mugger, and like the gambler in the bookies and casino, I can get wiped out financially, at which point I can no longer play.
There is however one good side to shorting a stock, you cannot get left holding a wad of stock that you bought at 60, and watch it drop to zero, because in effect you sold it before you bought it.
In real life if Perens Widgets were trading at 100 and I shorted a sell at 80 and a buy at 60 I'd go broke at the Roulette Wheel, fast. What actually happens is I sell at 99.95 and buy at 99.90, and just like the Roulette Wheel lots of player just sit there placing bet after bet.
But it still comes to naught but personal bankruptcy if we short anything that isn't going downhill, this is where we sort of come back to the mugging and rape, if you do not pass out in an alcoholic oblivion on the wrong side of the tracks at 1 am decked out in Rolex and Gold lame iPod, you don't get preyed upon.
Sure, rape and mugging and indeed gambling are still wrong, but your status as victim is always dramatically weakened if people can point the finger and somehow accuse you of in effect inviting it to happen.
Yeah, you can be out partying on the wrong side of the tracks at 1 am and come to no harm, (I was a bit of a specialist at this myself) but the pre-requisite is keeping your street smarts with you at the door. I used to go places (abroad) that literally had blood on the floor and bullet holes in the walls, but I could handle my beer, didn't have an attitude and was wearing mechanics overalls after a hard day at work, mainly you didn't hear my mouth over all the others.
The Halifax used to be a Building Society, if not the biggest in the UK them damn close, and all it was was a building society, but then in the nineties the Halifax, along with many others, decided it didn't want to be a building society any more, it wanted to be a Bank.
So it threw off the staid boring old tweed jacket and put its party clothes on and started carousing into the wee hours in places it wouldn't have been seen dead in before, and to those of us sat in the corner wearing overalls and quietly supping our beer away from the spotlight of professional life it was both an intrusion and also a foregone conclusion that it was only a question of time before someone decided to stomp on their face.
As much as we would like to place the blame for Halifax (and everyone else) tanking at the hands of the uncouth short sellers, the fact is that if Halifax had been prudent and stayed as a building society then this would never have happened, could never have happened.
SO now there is much hand wringing, oh dearie me, how can we apportion blame equitably?
As the old joke went, it is like playing pass the parcel (the parcel being a ticking bomb) in an Irish pub, all very well blaming the one holding the parcel when the music stopped, but the very act of playing was what decided your fate.
In my experience if you meet an incompetent employee, and then another one, in the same company, then inevitably the rot goes all the way to the top.
What we see here is the same thing, the Gordon Gekko greed is good mentality was prevalent throughout these institutions, from the fat cats at the top all the way down to the clerks at the bottom.
So where will it all end?
The USA has, astonishingly, effectively nationalised AIG by pumping 85 billion dollars into it, and the market response? AIG shares fell a further 22%, which was admittedly probably a whole lot "better" than what would have happened if left to themselves and simply collapsed.
However, closing the casino doesn't eradicate the gamblers or their culture, and this is the real issue here.
Fear is stalking the streets of the financial markets, and this is because closing one game or even casino in Las Vegas just means the punters will go elsewhere, Las Vegas takes a long time to contruct and to gain momentum, and once that momentum is built you can't just turn it off like a tap.
Well, you *can*, but nobody really has the guts to either bulldoze Las Vegas or Wall St in toto.
So now the gamblers are eyeing up the remaining tables in the casino, Washington Mutual, Wachovia, Bank of America, Morgan Stanley and Citibank for starters, and just like the Halifax and the teen on the wrong side of the tracks, they put themselves there, by choice, by free will, contrary to the warning voices, in the first place.
Now, like the tale of the frog and the scorpion, the shorters are going to continue to sting the frog half way across the river, and the only ones "immune" from their attentions are those who decided that discretion was the better part of valour, and maybe partying till the wee hours on the wrong side of the tracks wasn't really the best idea.
Make no mistake, this is the financial equivalent of the cuban missile crisis, we could well come out the other side, reasonably intact, on the other hand the global financial system could be changed forever, except this time the "us and them" isn't west vs east, it is casinos vs gamblers.
Lloyds bought Halifax because Halifax was starting to see a run on the bank, and it is impossible at this stage to say whether or not Lloyds has merely delayed the inevitable and also sealed its own fate this way. The new Lloyds Halifax simply is not "too big to fail" from the actual real monetary perspective, nothing is.
The only "crisis" in the financial sector is a crisis in confidence, and this crisis in confidence is what gives the short sellers their arena to operate in.
You cannot "fix" this along as there any roulette wheels open anywhere on the strip, they will attract all the remaining gamblers, and you cannot "fix" this unless you first accept the the problem all came from things like the Halifax deciding to become a Bank in the name of greed.
Rebuilding confidence in our financial institutions is the cure.
"how" that is done is the proverbial (in this case) 64 billion dollar question.