Go Figure: Shorts Make Money!

by: Barry Ritholtz

There were a slew of articles in the papers today about just how much money those damned shorts are making!

First up, the WSJ, who looked at who was killing it:

"Some hedge-fund stars of 2007 are having an encore year. In the process, they are defying skeptics who questioned whether they could keep their runs going.

John Paulson, who directed Paulson & Co. to gains of almost $15 billion last year, is up as much as 20% in some of his hedge funds through June 30, according to investors, thanks to continued bets on the woes of financial companies.

Philip Falcone, who saw gains of about 120% in his largest hedge fund in 2007, gained 42% through June in that fund, Harbinger Capital Partners I, from various commodity-related investments, among other areas.

It isn't necessarily surprising that investors who wagered against mortgage and housing-related investments are excelling, since the housing troubles have spilled over into 2008. The real challenge for these managers will be turning in similar performances when that gambit has run its course."

Next up, Bloomberg focused on the total amount wagered on the short side:

"Investors worldwide are betting more than $1 trillion on a collapse in stock prices.

Managers from William Ackman to Jim Rogers made a total of at least $1.4 billion in July with wagers against U.S. mortgage financiers Fannie Mae and Freddie Mac, data compiled by Bloomberg as of last week show. Harbinger Capital Partners staked $665 million that U.K. mortgage lender HBOS Plc would drop and Sao Paulo-based hedge-fund manager Francisco Meirelles de Andrade's short selling of Cia. Vale do Rio Doce is also paying off.

More than $1.4 trillion of equities worldwide are now on loan, about a third higher than at the start of 2007, data compiled by Spitalfields Advisors, the London-based firm specializing in securities lending, show. Almost all of that is being used to speculate that shares will fall, according to James Angel, a finance professor at Georgetown University who studies short selling. The global economic slowdown, $453 billion in bank losses and an explosion of funds that can profit from stock declines spurred the increase in short selling, helping send 22 of 23 countries in the MSCI World Index into bear markets."

Next, the FT had an interesting twist: The brokers and iBanks are making lucrative trades lending out shares to shorts!

"Conservative fund management firms and custody banks are making billions of dollars from short-selling by lending stocks to facilitate such trades in exchange for lucrative fees.

Even as short-sellers attract blame for driving big falls in financial stocks, financial services firms – including those targeted by short-sellers – are profiting from the investing strategy.

US prime brokerage firms, most of which are owned by big Wall St banks, will reap revenue of $11bn (£5.5bn) this year, according to a recent study by Tabb Group, a research business.

Prime brokerage units provide services to hedge funds. They do not reveal their financial results, but executives who work for the units say they make most of their money from lending to short-sellers."

Funny -- no one really looked at the reasons why the shorts were killing it -- namely, the credit and derivative system run amok, a toothless SEC and a Federal Reserve that was guilty of malfeasance in terms of their obligations to regulate lending institutions. 

However, this Bloomberg quote at least makes an attempt to explain the purpose shorts serve in the  investment eco-system:

"Short sellers are a very important part of the ecosystem of our financial markets,'' said Angel, a professor at Georgetown's McDonough School of Business in Washington. ``The same way that lions go after a herd, they go after the weaker animals. The shorts will pick on a company where there's a legitimate controversy over its valuation.''

Shorting ‘makes billions’ for fund managers   
Deborah Brewster in London
FT July 17 2008 22:16 | Last updated: July 17 2008 22:16

Never Have So Many Short Sellers Made So Much Money 
Alexis Xydias
Bloomberg, July 21 2008

As the Markets Throw Knuckle Balls, Hedge-Fund Stars Still Hit Home Runs   
WSJ, July 22, 2008; Page C1

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