H. Michael Arguello_

Combating Cascading Short Spirals

Thanks for the comments all.

Turkeyeys, I agree that a short circuit breaker by itself is insufficient. However with realtime short information being made available, special situation funds could take out short attacks. If the shorts stop at 19% per day, a daily basis is more than enough time for Spec Sit funds to do their homework. The problem right now, in my opinion, is that the current time window the shorts have been using to overload the system with sell orders is too short of a time to research a company and go the opposite way. The bear raiders have the advantage in that they know how many fiat shares they are creating whereas long investors are flying blind on the fiat float.

Once a company has collapsed more than 25% in share price in one day it begins the downward spiral of downgrades and panic amongst investors and creditors.

Short selling has its uses in the market, but the current abuses on the Street require a response. The uptick rule would be nice but truth of the matter is, modern buy and sell programs can easily get around it by using computers to trigger minor upticks with a buy prior to large sell orders.

Countrywide: Potential Short Squeeze in the Offing

If shorts see other shorts getting squeezed, it could very well create a short covering rally, which is typical in a bear market. We've had several during the recent downturn and given the high degree of short interest in the marketplace right now, it’s very possible. Add in the recent rumors of a Wachovia acquisition by JPM on Friday (courtesy of CNBC) and it has potential to be a catalyst for a short covering rally.

I believe (based on nothing but my own speculation) that most of the current CFC shorts are shorts betting against the deal going through. Shorting Bank of America, even with Countrywide's liabilities, is a very different venture than shorting CFC. Shorting a stock with a 9.5% dividend yield (as of Friday close), strong balance sheet, a large unrealized gain on an investment (the China Construction bank options and existing shares, currently have a net gain of approx. $27 billion) etc. is a nasty prospect. If CFC is not taken over by BAC, there is the prospect of a bankruptcy and that would make every short’s day. With BAC, no analyst I am aware of is forecasting the company goes out of business – as such, your potential gains are capped at some point and your potential liability is extremely high as the stock has the ability to appreciate a great deal form its current levels.

It does not help that at current prices, shorts are facing a ~ 6% squeeze immediately upon the transfer of the position. ALSO, the way the BAC deal is structured, at .1822 shares of BAC for each share of CFC, all non-integer quantities are being paid out in cash. So if you have 1,000 CFC shares, you get 182 shares of BAC and .2 x Price of BAC in cash (about $5.42 at Fridays closing price).

Plain English, shorts have to pay out the equivalent in shares of BAC AND a small amount in cash. It’s very similar to holding a short position through a dividend. This is assuming your broker allows you to hold through the acquisition (not all brokers do; retail brokerages in particular tend to place more restrictions on such events). Regarding trading at a higher price than the acquisition, it has occurred several times since this deal was announced. It would not surprise me one bit to see it re-occur, albeit briefly, in the current circumstances.

Anyways this scenario is POSSIBLE, and it appears to be developing. CFC shares, on a % basis, held up far better than BAC shares during Friday’s market and indeed, throughout much of last week. That indicates to me some shorts may be starting to cover and that is exactly how short covering rallies begin.

All in all, I felt it was worth discussing. Thank you for reading.