Selling the Short Sellers Short: Another Sign of Trouble

You always know real trouble is brewing when the government starts scapegoating short sellers. The SEC went so far this week as to make it nearly impossible for small traders to short any of the big financial stocks.

Explaining the new aversion to betting on falling financials, the SEC told the Wall Street Journal, "Drastic falls can end up destroying confidence in the firm altogether, which is not for bricks-and-mortar industrial companies." Oh, really? Try telling that to General Motors (GM).

The truth is plain enough to see. Bear Stearns (BSC) didn't fail because of its stock price. It failed because it was leveraged 34-to-1 into mortgages. Likewise, Fannie (FNM) and Freddie (FRE) aren't going out of business because of short selling or their share prices.

They're going bust because they're leveraged more than 100-to-1 into mortgages written against hugely inflated home prices. The SEC seems to forget that stock prices reflect a company's fundamentals, not the other way around.

Would you like to see a really shocking, telling chart. Take a look at the 2-year chart for the Financial Select Sector SPDR (AMEX:XLF), an ETF "to die for or with".

Can the government or the Federal Reserve save us from decades of loose monetary policies, easy credit and insufficient oversight? Is the SEC going to make a difference?

"The SEC's new ban on short selling financial stocks is a perfect example of the real U.S. government", writes Porter Stansberry at www.StansberryResearch.com.

"The government says it's all in favor of freedom (free markets, free speech, a free Afghanistan, etc.). But the government is only really interested in freedom as a propaganda tool. The moment someone's vested interest is threatened, the truth comes out. The last thing the government wants you to have is freedom."

Could Porter be correct? Will the government be the real party-pooper of free-market capitalism and the entrepreneurial tradition that made the US one of the great bastions of commercial success in the world?

In a moment we will share with you a few more thoughts about politicians that Porter Stansberry shared with attendees at Mark Skousen's so-called "FreedomFest" in Las Vegas recently.

Activist investor William Ackman is still teaching investors why they had better learn to "cut your losses"...which is the opposite of what he does when he invests other people's money.

Gossip and good sources tell us that Ackman made headlines this year shorting bond insurers MBIA (MBI) and Ambac (ABK). Ambac was an insurance superstar that just a little over a year ago was selling at almost $100 a share. Today it is a little over $2. Ouch!!

Ackman also announced a short position in Fannie (FNM) and Freddie (FRE) recently. But... investing in hedge funds has risk. Last year, Ackman started a $2 billion hedge fund to invest in one, secret stock. He raised all the money without telling anyone what he was buying.

He bought Target (TGT), and shares are down 38%. Yet Ackman is still buying... and raising cash. When Ackman finds a stock he likes, he rides it all the way down. He did the same thing with bookstore Borders (BGP), which fell 78% in a year. We're not hedge-fund managers... maybe that's why we prefer to cut our losses.

Our friend Dan Ferris who writes the newsletter Extreme Value could learn a good lesson from Ackman's aversion to taking one's losses. Following his advice, subscribers rode a now bankrupt home builder whose name begins with an "L" down to the bottom and also had subscribers invest in Borders and Home Depot (HD).

In all fairness to Dan, he had some very excellent investment picks during the real estate boom and in recent years had his subscribers invest in Wal-mart (WMT) when the stock was really cheap. We invite Dan to comment on his own investment track record and why he has been mostly successful up until recent times.

Back to Porter Stansberry: He really got personal when he spoke publicly at FreedomFest in Las Vegas. Here's what he wrote to us yesterday:

As some of you know, I attended Mark Skousen's FreedomFest in Las Vegas last week. I will not be invited back...

At least some of the people who heard my talk – which focused on libertarian themes like equality before the law and the coming collapse of Fannie Mae and Freddie Mac – were deeply offended by some of the language I used to describe our politicians. (If you are easily offended... why attend FreedomFest in Sin City?)

Why did I use such colorful language? I am outraged at the actions of our government. In only about 40 years, the buffoons in Washington have destroyed the good credit and the good name of our country. They are well on their way to destroying most of our wealth, too.

Our national politicians are, to a person, the most evil, vile, and unfaithful scum on this Earth. They are destroying our country for the sake of their short-lived desire for power. These men and women deserve the most disgusting things to be said about them. We owe them nothing but disrespect, which I heaped upon them with some fervor. I imagine most of you would have applauded my words. If you saw my speech, let us know what you thought of it: [e-mail]

If you agree or disagree with Porter, why not let him "have it" and share your response. Remember, Porter's words and opinions belong solely to him. Whether we think he is correct or not is up to each of us. We have to admire his courageous hubris and to speak so boldly. Again, you can let him know your thoughts at [e-mail] .

One thing we know, the government is known to step in and interfere with the free markets when things begin to sour. They go on "witch-hunts" and at the very least, desperate searches for scapegoats.

All they really need to do is investigate the White House, the Congress, and the so-called Self-Regulatory Organizations. The term "oversight" is becoming a sick joke, and this is one of hundreds of reasons our economy is in trouble.

Too bad more people don't listen to Warren Buffett, the late Sir John Templeton and the outrageously correct Doug Casey. They might have chosen better investments than MBI, ABK, GM, FRE or FNM.

Thank goodness for the freedom of the press and the US Constitution.

Disclosure: None

Comments

[apppro:]

And that's why we need MORE SEC action on other fronts. I'm really tired of hearing the 'dog ate my homework' argument from the shorts; and for that matter the so-called oil speculators too.
Yes the shorts caused this financial meltdown and yes there are oil speculators that caused the rediculous run up.
1. reinstate the up-tick rule
2. Crack down on naked shorting for ALL stocks
3. BIG crackdown on what is said on National TV and in the press

2008 Jul 18 08:38 AM

[apppro:]

and oh,
4. the gang-shorting by hedge funds. Even Cramer (whom I dislike) has been screaming for this measure.

2008 Jul 18 08:51 AM

[Ishortyou:]

It is certain that AMBAC and MBIA need to remediate their book of business in all their subsidiaries from risky liabilities specially CDS-RMBS-ABS-SIVs of uncertain value, if I were them I certainly would wipe out of my books any liability related to the housing market period. They also need to save all the cash possible to improve their book value, forget about stock buy backs, dividends, etc., just save money period. Once a solid book is attained their triple A rating would be reinstated and write new low risk book of business like the public bond ones. Looks like they are doing these but it will take time because it has to be done on a case by case scenario. They can also open or extend a line of credit to make sure to continue operations, dissipate doubts and prevent further downgrades from rating agencies.This coming back will be the best advertisement to recruit new clients.

static.seekingalpha.co...
www.mbia.com/investor/...
seekingalpha.com/artic...
seekingalpha.com/artic...
library.corporate-ir.n...

2008 Jul 18 09:15 AM

[glassbox:]

The shorts are typical sour grapes at this point. They are obviously hurting playing a leveraged game - the very same risk that banks took which the got them into the trouble that they are in now. Don't they know that short selling is a derived position - a position they are allowed to hold only on the dispensation of shareholders of the company. Now they are crying foul, that the SEC changed rules blah blah blah. Come on, wake up, shorting is dangerous, so eat your losses. What hypocrites!

2008 Jul 18 09:46 AM

[torfa80:]

I won't retype them, but I ditto all 4 points made by apppro. There have been some small companies driven almost bk due to naked shorting. Shorting is fine with REAL borrowed shares. Naked shorting serves no purpose except to steal money from the markets. The new rules should apply to all stocks, not just the financials. Wake up SEC!!!

2008 Jul 18 11:00 AM

[mkreisel:]

The uptick rule was introduced in 1932, the bottom of all bear markets.

The stock market worked perfectly after wards.

2008 Jul 18 12:58 PM

[oldlures1:]

I too agree w/ the comments of .
I understand the other has a right to his opinion, but it's complete bunk! And the fact that such skewed nonsense is posted on SA is not only reflective (in part) of what's wrong with the sytem, but makes me wonder why I keep coming back to reading SA -- I guess it's because the folks of E*Trade haven't provided a better, less-biased, source.

*sigh* Moving on now...

2008 Jul 18 01:00 PM

[Stockbuzz:]

Naked Shorts are against the law and should be against the law. The Hedge funds and Clearing houses should have the stock to sell it. When I buy stock I want to know my order was credited to the Company and hence helped the stock go up. Holding on to my order and handing over a IOU to my broker does not cut it. The T-3 should be enforced with no exceptions. If you want to hear how the big guys play us the small investor just listen to Podcast on the link below, you will hear Jim Cramer tell how when he worked at a Hedge Fund Shorting Naked Stock and how he could make a few calls to the media and kill a stock price.

www.deepcapture.com/ca.../

2008 Jul 18 05:27 PM

[flashrob:]

I could agree, about the speculators taking advantage of naked shorting...BUT THE TIMING OF THIS SMACKS OF SEC MEDDLING IN THE MKTS...

THEY SHOULD HAVE ANNOUNCE A FUTURE DATE FOR THIS RULE TO BE APPLIED ...not suddenly SPRUNG ON US
IN THE MIDDLE OF A PLAY...

LIKE CHANGING THE RULES IN A FOOTBALL GAME WHEN THE GUY IS RUNNING WITH THE BALL AND ABOUT TO SCORE A TOUCHDOWN...

DO YOU CHANGE THE RULES TO INVALIDATE THE PLAY IN PROGRESS...

I DON'T THINK SO...YOU WAIT 'TIL THE GAME IS FINISHED ...THEN CHANGE THE RULES...TO BE FAIR TO ALL...

FLASHROB

2008 Jul 18 06:58 PM

[glassbox:]

flashrob, well, I'm sorry if you are making losses on your shorts. But shorting is a dangerous game and if you managed your risks well, you should have know that there is this risk known as regulatory risk - the risk that regulators can change rules and therefore your holdings (short or long) will have its price affected. I don't see anything wrong here with them changing rules - they are regulators after all. Its just part of the capitalist system. If they listen too much to the big money guys and the shorts, then they would not be listening to the longs. You see, shorts and longs are on opposite sides. You cannot want to be a long and also want to borrow that same stock to short. If you want to take the latter view, then you should just sell what you have. Meanwhile, the one who wants to short the stock without the stock has no business in the whole affair and if he claims he is just part of the efficient market system - let me tell you he is just meddling with it.

2008 Jul 18 09:16 PM

[Ishortyou:]

there are much more risks that we are not aware of, and it's kind of difficult to asses them all at once and come up with a plan, I guess thats why we should always think about how much money we could loose in our investments or plays.

2008 Jul 19 09:44 AM

[nuts:]

I am not against shorting. But the naked shorting is not legal and made to destroy the market. If you want to short, make sure you have the borrowed shares to short. SEC changed the rule that allowed the big boy to do naked shorting but not the retail investors. The worst is that SEC never enforced the 13-day rule which they made. And 13-day rule, make the naked shorters get away from the naked short list. We all saw what happened in the last few days when SEC announced to restrict the naked shorting for a few financial stocks, the market became more stable. The view of this article is a piece of crap.

2008 Jul 19 10:06 AM

[Paul Killinger:]

Flash,

You bring up a KEY point. While actually borrowing stock will slow down shorting, if that was the primary reason for this week's turnaround, then this may be only a GIANT BEAR TRAP. We'll see.

I'm not ready to give up on oil or commodities myself. I believe they are far easier to monetize than the pieces of paper they call equities in this economic climate, and, hence, have far greater intrinsic value presently.

I'm not IMAGINING the bank runs and threatened bankruptcies in the transportation sector I'm seeing. Thousands of truckers have failed due to fuel prices already. The housing market will remain a shambles for some time. These trends will continue to work their way through our economy. .

2008 Jul 19 10:17 AM

[John Lounsbury:]

I put on and took off short positions to hedge my Goldman Sachs long position several time this week. Every time I went short it was 200 shares short for every 100 shares long in my portfolio. No problem putting any of the trades. I am a "small investor". I'd like to know if those claiming it is impossible for small investors to short financial stocks have actually tried to do it.

2008 Jul 19 10:23 AM

[Paul Killinger:]

By the way, I believe this RENEWAL will be VERY GOOD for our economy. Such creative destruction has always ended up making us stronger over time.

What we DESPERATELY need now, however, is a much greater supply of inexpensive ENERGY. This has been central to the worldwide economic miracle that has taken place over the past three centuries.

But we seem to be finally comprehending this economic axiom, which should make our future especially bright once more.

2008 Jul 19 10:34 AM

[Paul Killinger:]

Moratoria, tariffs, rationing and their related governmental activities NEVER work as a substitute for confronting economic realities. All they do is serve to distort markets. Schumpeter, Hayek and Friedman wrote extensively about this, but we only ever listen when it's too late.

2008 Jul 19 10:50 AM

[Ames Tiedeman:]

Short selling should never be banned under any circumstances. It is totally counter productive to ban short selling.

2008 Jul 19 01:24 PM

[texasgolfer:]

naked shorting is simple fraud, since you don't own what you sell. I can sell something I don't own, why should anyone be allowed to. The old joke about selling someone the Brooklyn Bridge remains germane.

2008 Jul 19 01:32 PM

[whisperonth...:]

I'm confused. If you borrow it, you don't own it. Sounds real simple to me. If you don't own it, you can't sell it. Still simple. If you can't sell it, you can't make money. STILL simple. The rule should be the same for ALL investors, ALL stocks. Keep the gambling in the back room so it only affects yourself, not the rest of us. Makes it less confusing. Maybe less fun, too, but tough stuff.

2008 Jul 19 01:54 PM

[secmaven:]

The SEC took away the naked shorting opportunity starting MONDAY in only 19 financial stocks including C and BAC as the banks. Did you see what BAC did in three days as the naked shorts covered rather than borrowed stock to get in compliance? They knew they had lost control in BAC and decided to cover even if it meant paying 10, 20, 30, 40, 50% more than the low. Don't worry, the borrowing requirement goes away in 30 days and actually went away even on Monday for "market makers" whoever the Hell these folks are (GS???) in this day of instant computer matching of buys and sells.

2008 Jul 19 08:19 PM

[flashrob:]

why MOST banks WILL FAIL...

and they ARE "no LONGER" A GOOD INVESTMENT...


...unless we withdraw from WTO and Nafta, to MAINTAIN A LOCAL HIGH-PAYING JOB BASE, drop Real Estate across the board to about 50% of what it is now, cut government spending drastically...AND EVEN IF WE DID ALL THESE THINGS the transition would still be tough...

WELL MOST OF THAT IS NOT GOING TO HAPPEN...so MANY BANKS WILL FAIL (sustained in appearance by the Fed...but they won't have much investment potential).

Consumers will get laid off IN GREATER NUMBERS AS BUSINESS'S CUT BACK...so they can show less than analyst's expected losses (mostly due to lay offs...who are also those people who will not now be shopping at Target, etc.)

Get the picture...WE'RE GOING DOWN...and the BANKING SECTOR is "LEADING THE CHARGE" FOR THE MOST PART.

Now maybe Obama has a solution, BUT I DON'T THINK SO.

So, IT'S RIDICULOUS TO ME TO WATCH THE "FINANCIAL SECTOR" RALLYING when

THERE IS NO REAL CHANCE FOR IT'S RECOVERY!

there's a lot more I could say, on fundamental economic issues...BUT THIS IS PRETTY MUCH OUR FUTURE.

NO REAL-ESTATE RECOVERY

NO BANKING RECOVERY

MORE TAXES

CONSUMER SPENDING CONTINUING TO DECLINE

MORE JOB LOSSES TO OVERSEAS

OIL continuing to be the new BLACK GOLD...WHICH MEANS AFTER A SHORT HIATUS ...PRICES WILL ONCE AGAIN START TO CLIMB...

all in all, not a good picture. THESE ARE THE UNDERLYING PROBLEMS...

SO MOST RALLIES ON THE MKT...LIKE THE ONE ON THE FINANCIAL SECTOR of the last few days...

ARE BASED ON ILLUSION.

So, my take is SKF looking real good going forward because MOST BANKS ARE HEADED FURTHER IN LOSS TERRITORY.

FLASHROB

2008 Jul 20 10:27 AM

[Ishortyou:]

Unless the government doesnt stabilize the housing market by stimulating demand to get rid of those overwhelming housing inventories the recovery is going to be slow.
And please stop giving building permits, those counties need to get the picture straight.

2008 Jul 20 04:10 PM

[contrariwise:]

How about posting a copy of/link to the speech? I can't comment on what I haven't seen.

2008 Jul 21 09:52 AM

[oldgoldbug:]

Naked shorts are similar to the "bear raids" back in the day which were a major cause of the 1929 Crash along with 10% leverage. So here we are again 80 years later with the same problem, only now it is 95% and more leverage. It is incredible that any of these banks on the wrong side are still standing....or are they? It all comes down to greed and Wall Street is insatiable. Bend the rules, break the rules, repeal the rules - none of it matters if they can make a buck and it doesn't matter to them who gets hurt.

2008 Jul 21 11:44 AM

[chistletoe:]

"The SEC went so far this week as to make it nearly impossible for small traders to short any of the big financial stocks."

this statement is nonsense.
It has always been against the rules to make a naked short sale
and small investors have never been able to do this,
only the big boys can get away with such a practise.
The SEC's action did nothing whatever to change anything,
all they did was hype, to try to change people's perceptions.
Guess they fooled you, huh?
I'm still short ...

2008 Jul 18 08:43 AM