Of Rumors and Bank Runs

My wife and I had dinner over the weekend with some close friends who were visiting from Washington DC. One of our friends just so happens to be Chief of Staff for a U.S. Congressman. He was interested in my views of the financial crisis, and the conversation quickly turned to the recent SEC-imposed ban of naked short-selling on a host of financial institutions (see SEC Restricts Shorting 19 Financial Stocks for background).

My friend and I agree on many issues. This was not one.

It is his view (and by extension, that of his boss) that short-sellers are to blame for much of the ills that have befallen U.S. banking stocks. He believes that by talking their books, hedge fund managers have effectively caused runs on banks. Moreover, he suggested that rumors passed from fund managers to CNBC, then reported on CNBC as fact (even if only as “alleged” fact), exacerbate the problem.

C’mon now, are you kidding me???

As much respect as I have for this friend, who is quite intelligent, I think he’s misguided on this issue. Blaming short-sellers for the failure of banks is as ludicrous as blaming Charles Schumer for the failure of IndyMac.

It is not the short-sellers that have caused the problems, but the banks themselves for lending irresponsibly thereby impairing their own balance sheets. Short-sellers are simply calling it as they see it, making logical deductions from the information at their disposal.

Now this does not mean that there are not instances of fraud, and I agree that fraud and attempts at outright manipulation should be prosecuted to the fullest extent of the law. However, to make a well-reasoned case for why certain banks are not healthy (even if consistent with your underlying trading position) is not fraud. Concerns about the health of banks not only should be raised - they deserve to be raised. The public ought to know what professionals truly believe about a company, for good and for bad. And for whatever it’s worth, the short-sellers often have it right (see Nasty, Brutish and Short).

Short-sellers provide a vital service to the functioning of our capital markets. Restricting their behavior is not only myopic, but also raises questions about the legality of those restrictions, and the “fairness” of the system (see Naked Fear for a nice summary of key issues).

And the point about how information relayed by CNBC can lead to a run - again, who’s joking whom? By the time information is disseminated by CNBC, it’s old news.

If you truly want to know about the health of a bank, there are two places to look - its balance sheet (if you’re so inclined to pore over such minutiae) and/or the credit default swap market (as bond traders are fairly keen at evaluating the health of corporations).

For what it’s worth, the credit default swap market has recently been sounding the alarm over Washington Mutual (see WaMu: Liquidity Options Running Low, Credit Default Swaps on WaMu, Uninsured Depositors at WaMu Begging for Trouble, or Death Spiral Financing at WaMu), among others.

To my knowledge, there has been no run on WaMu yet reported by CNBC. But if WaMu were to fail, I would not be surprised.

And that would have nothing to do with this post.

Comments

[ocd:]

You need to learn more about hedge funds roles in regards to the whole naked shorting issue. Legitimate shorting plays a critical role in the markets. But unregulated hedge funds have learned that millions upon millions can be made with nothing more than a slap on the wrist for crimes of manipulation caused by rumors and naked shorting.

Your friend, the COS, knows much more about the subject than you told us. Hopefully, you allowed him to reveal just how severe the problem is market wide rather than rolling your eyes at him like he was insane. Enough of this...Christopher Cox is on my bandwagon and that's all you need. Read the last paragraph of his speech in the link...

www.sec.gov/news/speec...

2008 Jul 29 03:38 AM

[T B:]

Interesting that Goldman Sachs is touted for having the wisdom to raise capital prior to any need yet Washington Mutual is chided for the same while also being able to boast current liquidity of some $40 bil. Articles such as yours in which you are unable to see the forest for the trees tells me this stock has bottomed and investors should expect perhaps surprising positive news to come from here.

2008 Jul 29 10:51 AM

[Blue Scorpion:]

You're incredibly naive. Naked short selling is a cancer in our markets. Until it gets fixed, our markets lack integrity and are stacked against the people on Main Street. Suggest deepcapture.com and thesanitycheck.com as places to start your education. The latter has a link to a Bloomberg piece on the insidiousness of NSS. Finally you can google "Bud Burrell The Greatest Crime in History" for a link to an interview he gave on the topic.

Educate yourself instead of tossing around uninformed generalizations.

2008 Jul 29 11:37 AM

[Blue Scorpion:]

You're incredibly naive. Naked short selling is a cancer in our markets. Until it gets fixed, our markets lack integrity and are stacked against the people on Main Street. Suggest deepcapture.com and thesanitycheck.com as places to start your education. The latter has a link to a Bloomberg piece on the insidiousness of NSS. Finally you can google "Bud Burrell The Greatest Crime in History" for a link to an interview he gave on the topic.

Educate yourself instead of tossing around uninformed generalizations.

2008 Jul 29 11:38 AM

[Bman:]

You need to learn the differences between a run on a Bank (deposits), stock price (ability to raise capital) and credit cost (open market debt costs). You seem to speak about all of these as if they are the same and impact a Bank the same.

2008 Jul 29 12:16 PM

[Bman:]

I wish I could short "Seeking Alpha"...the authors of these articles are bankrupt.

2008 Jul 29 12:18 PM

[Kinabalu:]

Schumer was never blamed for the failure of IndyMac. He was blamed for starting a run on the bank, two separate things.

2008 Jul 29 02:46 PM

[jjason:]

Dear Robert,

Your friend is NOT MISGUIDED on the issue. You are.

Naked short selling, according to what has been posted on seekingalpha, is illegal.

People and firms involved in naked short selling should be indicted and tried for security law violations.

Too many people have no concept of investing for the future and the economy has been screwed up for a lot of reasons...and naked short selling and short selling do not produce anything of value for the country.

There is a serious problem in our country when people don't understand what responsible investing is all about. And I include those people and firms on "Wall Street".

2008 Jul 29 03:09 PM

[tiredofallt...:]

If "Seeking Alpha" and some of its bloggers were to be sued for writing malicious, short-sighted and manipulative blogs, I would not be surprised.

2008 Jul 29 04:37 PM

[wnsmlssm:]

You are an idiot... Cheap shot is right. It IS people like you who cause all of this fear. I work for the bank and I cant tell you how many people come in quoting idiots like you. Internally, we are all charged up, optimistic, and ready to show the country what the bank is made of... and ultimately make a fool out of you!

2008 Jul 29 04:51 PM

[classic68:]

Hey Robert,

Get a life! Your friend is right and you are wrong. This article is weak at best. Out of the blue you through a shot at WAMU. Naked shorting is what everyone is concerned about not shorting in general. Naked shorting has been illegal for quite some time. It should have never been legal IMO. The SEC/Government needs to inforce the laws. They have been allowing naked shorting to continue for too long!

I ditto the other comments as well...

2008 Jul 29 05:14 PM

[classic68:]

Hey Robert,

Get a life! Your friend is right and you are wrong. This article is weak at best. Out of the blue you through a shot at WAMU. Naked shorting is what everyone is concerned about not shorting in general. Naked shorting has been illegal for quite some time. It should have never been legal IMO. The SEC/Government needs to inforce the laws. They have been allowing naked shorting to continue for too long!

I ditto the other comments as well...

2008 Jul 29 05:14 PM

[jack matalka:]

I bow to you in amazement. Putting your name next to the garbage
that comes from this column. The investing public is aware of what the shorts are doing. They'll wait them out. Sooner or later they have to cover what they (borrowed or believe borrowed) and then we'll see who gets the last laugh. There are 400 millions shares shorted recently. 85% of WM is institutionally owned long term. Not available for trade. 15% available for trade. Thats about 200 million. Do the math. Too many shares shorted not enough
available to buy back. Its a waiting game. Holders vs shorts who will give first? My money on the shorts. They'll give first and stampede the available shares and send the stock to double what is now. Your guess is as good as my guess.

2008 Jul 29 05:17 PM

[smokinj03:]

some of you idiots that left comments are most probably not calif resident, and have not seen first hand what kind of loans WM was doing. WM <b>will</b>... fall with or without the short sellers help.

2008 Jul 30 01:52 AM