lavalyn

Short Selling: Myths and Facts

glassbox: institutional investors allow the borrowing of shares because it generates additional revenue. "Yes, you may use these shares in this pension trust to be lent for short selling, in exchange for a fixed fee per month." The brokerages make money on the lend too, of course. There's apparently some interesting tax ramifications as well, as dividends paid by shorts are not treated the same as dividends received... I am unfortunately not a tax expert.

Short Selling: Myths and Facts

American: yes, that is correct. Ideally, the locate should also be a lock, so that other people can't use those shares as well for the short. In practice, because the successful locate for shorting generates revenue for the lender, that doesn't happen. I wouldn't blame the resulting increase in float on the borrower (short) side, but on the lender side... oh, who's on the lending side? The prime brokerages, like Morgan Stanley et al.

We've Crossed the Line from Capitalism to Socialism

RWilliams: think about this for a moment. While I think it's obvious that the financial system is in crisis, it's much less certain what the best solution is. Or even if the current proposal is going to fix or alleviate the *symptoms* of the problem.

The underlying conditions must all be resolved before you can really see improvement again:
1. Housing prices need to stabilize - and that's a function of the average Joe, not the bankers on the Street holding those subprime mortgage papers.
2. Banks need to deleverage - this new bill does that.
3. People have to regain their confidence in the economy - that will take a great deal of time.

It would also be nice if:
4. Irresponsible behaviour is punished. Fundamental to our capitalist free market philosophy is that the market will mete out its rewards and punishments by the worthiness of your own actions.
5. Those that need the bailout get it. Why can't you or I get bailed out on our debts (credit cards, mortgages, HELOCs) when we make stupid decisions, and yet the rich bankers on the Street with their 6 and 7 digit bonuses get to gorge from the taxpayer trough?

I'm unconvinced that this bailout is going to do more than the inevitable... from my perspective, the inevitable is a high inflation level (to wipe bad debts away) and a dramatic decrease in US consumption.

Hank Paulson, Buy-Sider

Schweizer: thank you for pointing out the obvious, but most often forgotten. People are still stuck with mortgages they can't afford, people are still stuck with homes in negative equity. This bailout of Wall Street does nothing to help those: it doesn't boost the cash flow of subprime lenders to pay their bills, it doesn't magically raise home prices, it doesn't take a bunch of homes off the market.

Should the SEC Force Hedge Funds to Disclose Short Positions?

glassbox: I don't blame people for wanting to hide short positions. Look at the response David Einhorn got when he announced he had an active short position against Lehman Brothers. Absolutely vilified. We may call diehard bulls "deluded" but there's no equivalent to "selling America short" for longs.

Idiotic Idea of the Day, SEC Edition

Why single out the short sellers? We should have all the hedge funds produce their long position disclosures daily as well!

Seriously speaking, all the negative force focused at the short sellers is just smokescreen. Investors of the fundamentals should be *delighted* that the short sellers are willing to give them good deals on good stocks. Oh wait, they weren't actually good fundamentals? That's not the short sellers' problem.

The inability to short sell even with locate is going to make the options markets interesting, to be sure. When the market-makers can't hedge, the market-makers will have to take market risk, and that will only cause rising premiums for that risk... and also a more unstable (and downward moving) asset market as investors become unable to hedge their risks and demand higher return for their capital.

This decoupling of the options and the spot market will cause a rout much reminiscent of 1987.

AIG: America's Insurance Giant

I'd go one further and say that financial guarantees are actually not all that hard to enforce. In probably one of the most free markets out there, the Futures markets have one of the most stringent protections against default risk out there: daily mark to market, automatic closeout of positions, a clearinghouse that backs all transactions, in a tightly regulated market.

A testament to how we can actually become more free by adding regulation.

AIG: America's Insurance Giant

"Never finance illiquid assets with liquid liabilities."

I'm sorry, but this blanket statement will be the one that will topple the entire banking system. The entire point of banks is to borrow short term and lend long term. What are bank deposits if not demand liabilities? What are mortgages if not long term and illiquid debt? And more to the point, how in the world did the banking industry exist before the wave of securitization, when you couldn't even repackage mortgages to, say, Fannie Mae?

The Real Risks of Deleveraging

"This paperclip is worth $1,000,000."

With that, all your venting about FAS 157 and 159 go poof in a little cloud of smoke. The alternative to an environment where we must value assets on balance sheets according to fair market value is one where we need not value assets to fair market value. And that is an environment where we can mark to whatever we want. Historical price, discounted future cash flows, a number that I thought up a few seconds ago, you name it.

If anything, FAS 159 showed the world how financially unhealthy Wall Street had become.

Witnessing History

Or that a rate cut wouldn't do anything. Look at the last year in review, especially the last six months. Interest rates have not risen... that has not translated to either lower consumer borrowing interest rates. And commercial borrowing rates have only risen, for that matter.

Four Questions About How We Got Here

JasonC: on the global scale, does it really make a difference? Lehman going bankrupt and debtholders getting pennies... versus Barclays buying Lehman out, and Lehman shareholders taking the hit instead. Barclays buying the shreds of Lehman doesn't make the value of Lehman assets increase. Surprisingly enough, it *is* a zero-sum game, just a matter of who gets burned.

Given that the Bear Stearns, and then Fannie Mae/Freddie Mac bailouts created a reputation that the "Fed has your back," a collapse is definitely necessary. Systemwide, worldwide, maybe some sense can be put back into credit worthiness review, instead of letting the US Treasury subsidize every ailing company.

Four Questions About How We Got Here

There has to be a (fuzzy) line between maintaining stability in the marketplace and letting the market reward and punish its participants. Wall Street, what do you think of when you read those words? To me, they bring images of ruthless profit-hungry vultures that will punish any misstep of any company from the corporate ideal of the bottom line. Look at their analysts, moving markets with the magic words "Market Outperform," "Conviction Sell," "Overweight." Listen to the conference calls, hear them harp on next quarter's profits... lash out at any deviation from the mantra of profit profit profit.

The very meaning of the phrase Seeking Alpha is an underlying belief that superior research, superior reasoning, and superior decision making results in superior returns. The flip side of that is that inferior decision making results in inferior returns.

Lehman Brothers made inferior decisions, choosing first to hide their assets and refrain from deleveraging in April, then continuing to try to hide their assets in "Level 3" in July. They chose to redouble their bets when they had a good base of capital (share price) that they could have deleveraged with instead. They chose to ask too much of a price of the Korean Development Bank in June. And in doing so, they totally forgot that they were a bank, a wholesaler of financial risk. The role of a bank is to *manage financial risk*.

Equity holders deserve nary a penny for holding to the end like this. Debt holders deserve, as dictated by insolvency law, that they will get priority recovery on those debts. Why should they get more, at your and my expense?

Frannie Bailout: Private Profit, Socialized Risk

I agree that this is very bad for the US economy. Effectively, the US Treasury has chosen to make the same bet as the GSEs have. They are wagering on the recovery of the housing market, in guaranteeing the debt of Fannie and Freddie. And here's where things get really bad: if things go well, common shareholders win. If things go bad, the government (and therefore the public) pay more interest and issue more debt.

Frannie Bailout: Private Profit, Socialized Risk

FNM and FRE debt paper. At this point, any deviation of it from US Treasury is arbitrage-able.

Frannie Bailout: Private Profit, Socialized Risk

To be sure, bankruptcy and insolvency hurts all capital holders. I may as well also say that I am a fan of the nationalization of the two GSEs, and am in full agreement that their existence is beneficial to the US and world economies. Where we disagree is whether the taxpayer bailout of these two giants is appropriate.

Shareholders are getting zeroed. Is a zeroing of the shareholders punishing? Certainly. Would the common man be able to get away with that? No, a common man 1) would never be ABLE to get into this situation, as banks do credit checks, 2) would lose much more than their investment. They'll lose their house, their car, everything. Put it this way, if I had any semblance to a government guarantee of my loans, I'd be investing it left right and center, on every investment, high risk or low risk. If a corporation I owned had such a guarantee, it'd practically bet the entire bank on the 00 in roulette. It wins, big bonuses to upper management. It loses, who cares. Seems to be what happened in 2005 for FNM.

The bailout protects debtholders. Should they be protected? I'd be inclined to say no. It is that default risk which keeps securities fairly valued. Do you think it's "fair" that GSE debt traded at a premium to US Treasuries, payouts made to Chinese and Japanese bondholders above US Treasury yields, while being fully backed (implicitly) by the government/taxpayer?

My take? I would have left Fannie and Freddie to its own defenses. Explicitly deny any sort of bailout. Expand Ginnie Mae, which is explicitly backed. If FNM and FRE hypothetically survives that ordeal, so much the better for everybody. But if they're going to be privately held, with private profit, they (and their creditors) should be taking private risk as well.