Bloomberg reported today that, back in July, David Einhorn and some other people decided that (1) betting against European sovereign debt was, and would remain, a good idea, but (2) doing it in CDS form was kind of dumb, so (3) they’d switch to doing it in physical form, by borrowing and shorting the debt. Here’s what Einhorn had to say in his July investor letter:
The letter touched on two risks tied to credit swaps on European sovereign debt, including regulators’ attempts to fashion a Greek bailout in a way that prevented the contracts from paying out. The second risk was the possibility that banks that wrote billions of dollars in credit swaps on sovereign debt might not be able to make good on their obligations should a country such as Greece actually default.
Let’s talk about that first reason for a minute because I think it’s sort of illuminating. The problem is that Europe was in July, and is now, and wow that’s depressing, trying to cobble together a “voluntary” debt exchange where holders of Greek debt happily hand it in to Greece and get back a thing with a 50% face value haircut that is also a piece of crap. If you’re a European bank who owns Greek bonds and CDS to hedge them, and you feel pressured to accept that deal, then you feel like the “insurance” you bought on your bonds should “pay out,” I suppose, though that’s all fairly hypothetical. If on the other hand you’re David Einhorn and you bought CDS and then Greece haircuts its debt, you feel like your bet against Greek debt has been vindicated so it should pay out. But it doesn’t, says ISDA, because the exchange was voluntary and there was no “credit event” under the rules governing your CDS. Read more »
If you think a company has a good business and shareholder friendly management, you might consider buying its stock. If, on the other hand, you found a company that you were pretty sure was managed by a bunch of baboons, it might make sense to short its stock, and maybe publicize your conclusions via a PowerPoint presentation and/or an ironic-adorable coffee-foam doodle. In practice, though, there are a whole lot of cases where smart investors light upon companies managed by baboons and buy them anyway.
Weird, huh? Conveniently there’s a neat paper out of NBER today (NBER version here, free version here), by Wharton professors Alex Edmans and Itay Goldstein and Columbia professor Wei Jiang, about how feedback effects can limit the efficiency of stock markets. The idea is that stock prices send a signal to managers about whether or not the company’s projects, in the judgment of the market, have a positive or negative expected NPV. Buying stock because the company is doing good stuff pushes up the stock price and tells managers to keep doing what they’re doing. Shorting stock because the company is putting investor money into paper bags and lighting them on fire pushes down the stock price and tells managers that maybe a change of strategy is in order. But if you short the stock because you think that the lighting-money-on-fire strategy will lead to ruin, you run the risk that managers will take that feedback seriously and put away the lighter fluid, and the stock will go back up. Or as the authors put it:
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Short sale bans. Is there anything they can’t do?
Maybe. But does it matter? If your position is just that “speculation” on stocks is the moral equivalent of puppy-murder and should never be profitable, then you just say things like “let’s ban short sales” and don’t worry about the details. You take shorting of bank shares as a personal affront, and your goal is not to have functioning markets but just to prove that you’re tough. And your name might be Jean-Pierre Jouyet:
Jean-Pierre Jouyet, head of the AMF, the French securities regulator, said on Thursday night: “They [investors] wanted to test French resistance. This is our response, as always very determined, and it will be so for all those who want to put us to the test.”
But, as we’re seeing with new short sale bans from France, Italy, Spain and Belgium, this approach sometimes has problems, because most short selling takes place in an actual world where other things happen too. Like:
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Not satisfied with taking down the names of everyone shorting Italian stocks so it could give them disappointed looks and ask them if they feel good about themselves for making Nonna cry over her lost pension, Italian securities regulator Consob has started using a little “moral suasion” to get their buddies to cut them off.
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Last month T2 Partners’ fund declined 2.8 percent in January, with declines of 4.3% (net) in the last five months, which managing partners Whitney Tilson and Glenn Tongue noted “in isolation, isn’t a terrible number.” Having said that, “given that the S&P has surged 23.5% over the last five months, this has been, by far, our worst relative performance in history.” So, some thoughts are necessary.
On strengths vs weaknesses: “Over time we’ve been quite successful shorting fads, frauds, promotions, declining businesses, and bad balance sheets. Where we have had much less success, however, especially in recent months, is shorting good businesses that are growing rapidly, even when their valuations appear extreme. Such open-ended situations, regardless of valuation, are very dangerous, so going forward we will avoid them entirely unless we have a high degree of conviction about a specific, near-term catalyst.” Read more »
So the SEC voted 3-2 in favor of restricting short-selling today, at the risk of pissing off Goldman Sachs, whose head of US equity trading Paul Russo had been lobbying against the proposal for some time. However, even Mary Schapiro knows that no one can truly make a full frontal attack on GS, and mitigated the rule to take into consideration Russo’s advice, deemed to be the “least harmful”: trigger a circuit breaker any time a stock has dropped 10% in one day.
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Our fave porn-loving regulators are taking a stab, yet again, at short selling, considering measures to curb it “soon.” But while one can only laud Mary Schapiro’s effort to sugar coat the proposal, she’s not helping the SEC regain any kind of respectability and seriousness, and at this point, Mary might want to consider a lesson or two from Lucas van P.
This is what she had to say, and if someone can translate, please stand up: “It is difficult to connect the dots and ferret out wrongdoing as trading activity frequently occurs across various markets and each market is only able to readily see trading activity conducted in their own market.”
Cityfile reports that Jim Chanos has closed on a triplex at 3 East 75th Street (neighbors!). Chanos paid $20.365 million two months ago for the 7,800 square foot space. In the same way that rich people often have so many rooms they don’t know what to do with them all and end up devoting one to a single activity such as the Gift Wrapping Room, Chanos’s abode will include a 20×20 reserved specifically for candle-lit Ouija board sessions (really not that frivolous when you consider that it’s an integral part of the short selling biz. There will also be a guest bed for Alfred Winslow Jones, often summoned in the O-room during idea sessions (slumber parties) with the boys (Einhorn, Ackman, Tilson).
Related: The “Wizards” Of Short Selling
Joanna Shields Buys, Jim Chanos Closes [Cityfile]
Harvey Pitt has been named deputy attorney general of Alabama where he will be investigating “short sellers and false rumors involving Colonial BancGroup, actions designed to drive down the institution’s stock price.” CNB apparently approached Pitt about the gig knowing that rumor mongering and wicked short selling are favorite topics of the erstwhile SEC chairman and current private citizen, which he believes are “serious problems…[that have] led to a whole host of additional problems in the marketplace.” Pitt also hilariously noted that he has been contacted by other firms known by those in the know to be short-seller targets, but has thus far been rebuffed because they’re self-conscious about having their asses tapped (sayeth Pitt: “They don’t want it known that they are the targets of short sellers”).
The P-man’s compensation for the job has been disclosed but even if he’s being paid in Lehman stock the whole thing sure to pay off in spades. The plan is prettay prettay genius–make up some stuff up based on speculation and hearsay about malicious shorts being responsible for CNB’s horrific performance (the bank’s stock lost 53 percent of its value this year), and then take the case study to Cox as evidence that the SEC really needs to extend now-defunct emergency rule to all financial companies which would mean KA-CHING for Pitt’s newly formed RegSHO.com. RS is a web-based real-time electronic stock lending and location service that matches traders with available stocks that can be borrowed for short sales and offers immediate data on the short-sell market. Obviously the biz would be made exponentially more profitable if the SEC expands and extends the rule, practically forcing Pitt and Co to charge customers for both locating and pre-borrowing.
One error in Pitt’s flawless money-making scheme, however, is the matter of his partner, John Tobacco. Anecdotal evidence shows that he’s a bit of a Tim Sykes (please refer to the last comment on this thread).
Call Him Deputy Attorney General Pitt [NYT]
CEOs Launch Web Site To Protect Short Sellers: Firm Aids Compliance With SEC Naked-Sale Rules [Washington Post]
I’m going to present this one without commentary. To parse it would be to meddle with its genius (genius that, if it’s doing its job right, will haunt your dreams). I will however put a few things in bold that I think you should look out for:
Most people understand that shorting something means you’ll make money if it goes down. Here’s how it actually works:
It’s Saturday afternoon and you stop by your ex girlfriend’s apartment to pick some of your old stuff. You guys are friends and all, so you just let yourself in. You’re grabbing your clothes from behind the fridge and see that she’s got a case of Budweiser sitting in the pantry next to it. You happen to be on your way to a pool party and you know that your frat boy friends will be out of beer by the time you make your “casually late” entrance.
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