27 comments on “WAR is everywhere (on Wall St.)

  1. Ken writes:

    I still don't know what to think about the bailout. Supposedly, if successful, banks will be rid of risky mortgage investments, credit will be restored and the Fed would turn a tidy profit by buying on the cheap. I feel like something needed to be done to restore investor confidence somewhat, but am not convinced this is the solution yet. What really killed the banks was getting rid of the uptick rule in shorting stock. That basically made shorting a self-fulfilling prophecy, killing financial institutions' market value and limiting their ability to recover.

    AIG's bail out was because they were on the wrong side of bad credit default swaps. Its demise would leave those positions uncovered and would continue to wreak havoc on the markets. I don't think anyone really cared about their insurance side; it's AIG's investments and participation of the credit markets that had people worried.

    Forcing ML into BofA hands was motivated by the Fed, but it's not like BofA had to have its arm twisted. ML is actually a great fit for BofA, and Ken Lewis was even rumored to have been interested long before all this crap started.

    And lastly, Bernanke's comment on recession might be from a pure economic standpoint, where a recession is defined as "two consecutive quarters of GDP decline" which I don't believe we've had yet.

  2. I take issue with your points, Ken. But you know all this better than I do:

    1. Shorting, naked or otherwise, has not been proven to have had any undue negative effect on the market. Every short starts with borrowing shares. A naked short is just on loan, as opposed to on margin. If you blame shorters for dragging down the markets, why are you not blaming irresponsible lenders?

    Secondly, without shorts, you do not have a healthy counter-opinion about postitively-biased market. Shorts lead people to uncover the dirty on companies like Enron or WorldCom. Shorters face greater risks than buyers, so short interest isn't just speculation.

    I agree naked shorting is something that might need regulation, but ultimately it's offered because greedy people think the market will always go up, and that exuberance should be checked. Look at Goldman Sachs today… fell $30 without shorts.

    2. BoA's arm wasn't twisted… but what was the government doing there in the first place? What about when the Fed to seized WAMU to sell it piecemeal to JP Morgan? It is a great deal, and we're looking right now at the future giants. But the private sector should not have to resolve that with the Fed.

    3. Bernanke's comment is antediluvian. I know the official definition for a recession… and frankly it doesn't work. Look around and tell me this isn't a recession bordering on depression. You can't trust the government statistics on GDP, and even if you could, remember that inflation causes nominal increases in GDP. After the Fed hid their M3 stats, what data we have indicates mad money printing. GDP and CPI are a heavily padded numbers right now.

  3. ken writes:

    Touche. I don't necessarily disagree from with your original post. I was just offering the other side, since I see it everyday here.

    1) I still argue about the naked shorting. I don't disagree that shorting should be allowed, but up until July 2007 (which coincidentally, was shortly before the credit crisis struck), the SEC had the uptick rule in place. Stocks had to tick upwards once before you could short it, which in my mind, seemed to work ok for ages. This measure was in place to prevent massive short selling which I believe many of the hedge funds ended up doing in the past several months. This tremendous pressure is tough to overcome and has more effects than just determine true market price. Banks lend and borrow based on their net worth using overnight funds, and having their stock crushed in a short span greatly hinders their ability to do business.

    While I'm not blaming the fall of the financial institutions solely on the shorting of their stock, I believe it helped contribute to their demise in a swifter fashion than traditionally. But it was the SEC's own fault for doing away with the rule that was supposedly to help preserve some semblance of order. And to make up for that gaffe, they banned it outright, which I also don't think is the right thing to do.

    2) I agree with you that the government may be too involved at this point, but just from their point of view, they were probably thinking that they had to do something amid all this mayhem.

    3) The only reason I bring up the textbook definition of a recession is because Bernanke is an academic. Maybe that's why everything is going to shit. But then again, Henry Paulson isn't an academic (he's a BANKER) which probably explains all the wheeling and dealing that's been going on. Again, I agree that the government has gone too far. Check out all that stuff with Citi vs. Wells Fargo. Why the hell is Citi still around? Wells made a totally unsolicited offer for Wachovia and was willing to bear all of the loss, needing none of it backstopped by the government. Why is the fed still hanging around in these discussions?

    All in all, the points that I raised earlier was more as a point of clarification, and not an argument for bailouts or government intervention. This whole mess is everyone's faults: the bad lenders who irresponsibly lent to people who they knew couldn't afford it, the bad borrowers (namely speculators) who borrowed, the Fed for lowering rates so low, the rating agencies for not understanding the nature of mortgage-backed securities, and all the banks for continuing to deal in this stuff even though they didn't know either and didn't have the guts to say no. (Contrast this to Wells Fargo, a traditionally conservative bank, who barely touched CMBS throughout this whole ordeal and is now one of the few banks consistently turning profits.)

    Now the market is getting crushed on a daily basis, and I'm hoping it'll end soon.

  4. I know Ken, I was just playing devil's advocate, as the points you bring up are often in the media and deserve conversation.

    Two quick notes:

    The reason the government is still hanging around discussions is because technically the deal between Citigroup and Wachovia had already been brokered I believe. Giving Wachovia to Citi would be some kind of breach of trust. On the other hand, I consider it a major breach of trust when Citi offers a laughable sum for Wachovia… the gross amount would have cost $10 billion… FOR US! Ridiculous, the government would be smart to let Wells have it, screw trust, too late for that.

    Also, as upstanding a bank Wells Fargo is, I'll just point out that they have a ton of Alt-A Cali-based mortages on their books (like BoA) that were written at a time when Alt-A requirements were borderline sub-prime. Now the reason Citi can't match Wells' $15.2 billion offer for Wachovia is clear to me. Citi has massive amounts of pay-option ARMs. While Wells is not immune to future pain, those pay-options are going to hit harder and earlier than Wells' Alt-As.

    In other words, both are irresponsible, but Citi's action may end up being very very fatal.

  5. Ken writes:

    Yeah, I know that Citi had an exclusivity agreement but that was all under the premise that the FDIC would backstop their losses. All the FDIC needs to do is pull that commitment. Some people say that it would be bad business practice to do so, but these are extenuating circumstances and the Fed is only acting at a "last resort" (arguably, and for better or worse). Companies shouldn't expect the Fed to give them these deals or backstop their losses. If Citi can't hang, that's tough for them. It now sounds like they'll be splitting the Wachovia treasure…

    Which reminds me, maybe I should move my bank account from Citi to BofA…

    And you're right also. No bank is immune from all of this. I just think that Wells runs a tighter ship than most, which deserves some merit. Somehow the words "upstanding citizen" and "bank" don't run well together for me right now, so I don't think Wells is one. But Warren Buffett is a huge believer in them, and I guess they deserve some praise for not toppling. (But paraphraising Chris Rock, in some ways it's like boasting when you say "'Man, I ain't never been to jail.' You idiot, you're not supposed to go to jail! Only ignorant asses brag about things you're not supposed to do.")

    And check the news today. The Fed is going to start buying up banks? This is absolutely ridiculous.

  6. Just wanted to point out to you that, regarding the shorting ban, it looks like it's actually done more harm than good. When the SEC restricted short-selling on financial stocks, we lost immense amounts of liquidity in the market. Hedge funds are not pairs trading, short squeeze rallies are not around to build positive momentum, nada. Volume today is tepid compared to the amount the market fell.

    Check out the banks, look at how low their short interest is, you'd think it was a raging bull market! Shorting is *supposed* to bring about "their demise", it's as healthy as a forest fire clearing the brush. Without it, there is no floor to prices, as there are no shorts being covered.

    So should the SEC now have an uptick rule to sell too? That's why their ban is idiocy.

  7. Ken writes:

    I agree that the ban was bad for the reasons that you listed, but the uptick rule worked for so long. I just don't understand why they got rid of it.

    I don't see how unrestricted shorting is healthy. You're arguing that it brings prices back to equilibrium, but I don't see it that way. If I was in a hedge fund, I'd short the hell out of some obscure, yet profitable company (low volume traded), cover my position when the stock is low, and buy even more to reap the benefits of the upside. Unrestricted shorting creates short term volatility that does not jive with how a company is doing. As we've been seeing, the market is completely irrational, so I don't trust investors to sell/short a stock until we reach the point of equilibrium. In all reality though, I think it's a mix of both of our points.

    Check out Buffett's Berkshire Hathaway's Class A shares of stock. It's trading above 6 figures per share with a 52-week high of over $150K. When asked why he doesn't split the stock to make it more marketable, his response is that he wants the stock to reflect the intrinsic value of the company. A lower, or more marketable stock price would subject his stock to irregularities (i.e. through shorting) not reflective of what his company is worth. This whole thing is funny because my line of business takes advantage of discrepancies in companies' values and their stock prices, so I don't know why I'm resisting so much. I guess I'm just a pure fundamentalist. I don't get any of this technical investing crap.

    Plus, how is the concept of shorting natural anyway? In what other industry can you sell something that you don't own? That's why your rhetorical question of having an uptick rule on selling stock is inappropriate.

  8. How do the actions you would do as a hedge fund in that case cause anymore volatility than buy/sell? You short the hell out of that company, or you can buy the hell out of the company, both are distortions and are used all the time. Your hedge fund could easily accomplish something similar with excessive buying, then getting out when the sucker momentum is strong. Clearly the last few days of market instability have had nothing to do with shorting, and in fact have been in spite of it.

    The reason why Buffett does not split shares is because splitting creates a lower barrier of entry that encourages speculative buying/shorting, not because it encourages shorting per se.

    Buffett (and fundamentals) are generally right in the long term. Technicals are about the short term; it isn't crap it's psychology. You can't tell me BRK-A follows the day-to-day intrinsic value of the company at all, even if it does in the long run. You can't tell me that if Buffett died, there would be no impact on his company's stock prices, even if its intrinsic value didn't change. On paper, a split should have no effect on reflection of intrinsic value- it's pure psychology.

    As for shorting being natural, well you haven't been to Vegas my friend 🙂 No seriously, people/industries sell things they don't own all the time (accounts payable, real estate, etc.). But that's not shorting, which is just a promise to buy. A naked short then is promise to buy with money you don't have, so therein lies the real problem: leverage.

  9. Anonymous writes:

    You make good points. I guess I'm just old school and conservative, and the radical hedge fund mentality doesn't sit well with me. The thing with excessive buying (in my mind) is that you're always dealing with a finite number of shares. With naked shorting, you're borrowing shares to sell, which theoretically increases the share count via the transaction.

    And I do stand corrected. It's the speculators that Buffett tries to avoid. (Damn speculators!!!)

    And great point about selling AP, AR, RE, etc. The one thing I have to say though, is that you're selling a right to those assets. So even though you don't technically have possession yet, you are offering the right as consideration. The thing with shorting is that you don't have a right to the stock that you're selling. You're basically offering specific performance of "promising" to buy a stock at a later point.

    I think we could probably argue about this ad nauseum, and it basically comes down to a basic difference in our investing ideology. To me, shorts and other options serve primarily as a hedge, not as a means to profit. But then, I'm just conservative as hell.

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