In the House Financial Services Committee hearing Monday on Bernard Madoff’s $50 billion alleged Ponzi scheme, some good points were raised by Congress members of both parties. One was particularly relevant:
Representative Stephen F. Lynch, Democrat of Massachusetts, said short-sellers seemed to know about the Madoff fraud and the S.E.C. should have seen it coming. “The short-sellers knew it was coming and they invested in it — how did they know and the S.E.C didn’t,” Mr. Lynch asserted. “These short-sellers were able to diagnose it, bet on it and make a killing on it.”
Lynch’s point was a little unclear. Madoff’s company was not publicly traded, and thus couldn’t be shorted in the traditional sense. Lynch could have been referring to two related issues though. One is that hedge fund managers such as Harry Markopolos were apparently coming to the SEC to blow the whistle on Madoff. But their appeals fell on deaf ears
The other point is, as John Berlau has noted before on OpenMarket, that short-sellers knew the subprime crisis in general was coming and profited from that fact. Had short-selling rules been liberalized for vehicles such as mutual funds as well as hedge funds, many more retail investors could have profited as well, and the bubble may not have grown nearly as big if more shorts had balanced out the bullish longs.
Lynch should be applauded for standing up for the beleaguered shorts. And his words of praise for them hold out hope that Congress may, at last, come to realize that contrarians – those who view rapidly (apparently) appreciating assets as dangerous and invest so as to dampen such “irrational exuberances” — play a valuable and suppressed role in the market. Perhaps, that thinking may lead to reforms of laws discriminating against short sellers.
It’s been called a ticking time bomb by Investor’s Business Daily. CNNMoney asks if this will be the next disaster. Yet the Feds are delaying one key in bringing stability to our financial markets.
As a $62 trillion dollar over the counter market, CDSs need an exchange or central clearinghouse to provide transparency and collateral requirements. CME (formed from the Chicago Board of Trade and the Chicago Mercantile Exchange) and the Clearing Corp (formed from 17 financial players including UBS and Goldman Sachs) have stepped up to the plate. Clearing Corp could have had a clearinghouse up and running within a week or so; however, the Fed has pushed Clearinghouse to obtain a banking license which will probably delay its opening until next year. But with each bank that is removed from this house of cards the threat of meltdown is increased. The banks are falling one after another internationally, and with the CDSs so intertwined, its only a matter of time until when you take away one more card and they all fall.
According to Bloomberg, “Barclays analysts estimated in February that if a financial institution that had $2 trillion in credit-default swap trades outstanding were to fail, it might trigger between $36 billion and $47 billion in losses for those that traded with the firm. That doesn’t include the market-value losses investors face as the cost to protect companies against a default widens.”
Perhaps it would be a good idea for the Feds to speed their approval process?
At the peak of the real estate boom, there was one group of individuals who said the bubble was about to pop. They pointed to overvalued land and bad underwriting of loans. And they bet their own money on their beliefs. Who are these unsung prophets of the subprime bust: the much-maligned short-sellers, whom both Britain, as Iain Murray reported yesterday, and now the U.S. Securities and Exchange Commission temporarily want to ban in an effort to keep the share price of financials from going further down.
On Thursday, John McCain foolishly called for the ouster of SEC Chairman Chris Cox because Cox hadn’t cracked down on so-called “naked” short sellers and supposedly “kept in place trading rules that let speculators and hedge funds turn our markets into a casino.”
McCain would have been on better ground asking for Cox’s ouster based on his refusal to push for reform of the growth-killing and counterproductive Sarbanes-Oxley accounting mandates and for opposing CEI’s lawsuit against the law’s unconstitutional Public Company Accounting Oversight Board. The “naked” short-selling McCain was referring to — which doesn’t mean that someone is shorting a stock disrobed at their computer, but refers to when someone trades with shares that aren’t there — is already illegal. (Although the SEC steps recently taken to prevent it could have costly effects on broker-dealers who would have to redesign their computer systems. More on that in another blog post.)
But later that evening, Cox would apparently prove the even bigger fool by reportedly telling Congress that the SEC was going to temporarily ban all short selling! According to the Associated Press, “Cox told the lawmakers the SEC may put in a temporary emergency ban on all short-selling — not just the aggressive forms it already has targeted, according to a person familiar with the matter. The ban might apply to stocks of selected financial companies, to all financial companies or even possibly to all public companies.”
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