The Blame Game and Window Dressing

In November, 2007, after 9+ years trading on Wall Street, I left for the greener pastures, of, well, nothing really. Strangely, being outside of the Wall Street "inside" information flow has allowed me to get much more in touch with why America has some of the problems we do. My free time allows me to read much more of the propaganda we are subjected to daily (this isn't supposed to sound militant!) and help me figure out what's really causing the problems.

The main problem is, Americans are by and large, ignorant. (I was shocked at the comments on this writeup of the airline letter, but it's important to realize how many people really believe the hype!) Maybe "gullible" is a better word, but we trust the media to deliver us our news, and basically, our opinions. However, the problem we are currently running into is that Americans are not so stupid that they don't realize when things are shitty. Treasury Secretary Paulson and SEC Chairman Cox can tell us that things are not really that bad all they want. They can tell us that housing is bottoming, and that the outcome of the current financial crisis (make no mistake - this is a crisis) will be short lived, not so bad, and quickly resolved. They can tell us that inflation is mild - if you take out food and energy costs, prices are only up 2 tenths of a percent - see? Things are fine!!

Still, your average American, however optomistic, realizes that when they go to the gas station they can't just ignore the energy costs and focus on "core inflation" when they spend $4+ a gallon to fill their tank. They can't ignore food costs when they see that a bag of pecans costs eight bucks, egg prices are up 40%, and milk is up 26%.

Then we have the homeowners. After we're done blaming the predatory lenders, we're still screwed. We already tried blaming the speculators - even major companies are BEGGING you to blame the speculators to cover up their own poor business decisions. Jeff Matthews has an interesting writeup on the asinine airline letter I blogged about last week. So now what do we do? We blame the short sellers!!!! Joe Nocera put it well in today's NY Times:

So let’s see now. Mortgage lenders make tens of thousands, if not millions, of subprime loans to people who don’t have the ability to pay the money back. Wall Street institutions then buy the loans and package them into complex derivative securities, while the rating agencies give them triple-A ratings, which we now know that they knew amounted to a ticking time bomb. (E-mail will get you every time.) Then when it all goes to hell in a handbasket, who do they blame? Why, short-sellers of course!

The most amazing part is that the Securities and Exchange Commission seems to be buying the argument, with the announcement that it will conduct an investigation into supposed rumor-mongering by hedge funds and short-sellers. Of course there was rumor-mongering by hedge funds and short-sellers — the big financial companies haven’t exactly been model of openness as they’ve had to write off billions in bad loans, and nobody knows how bad it’s ultimately going to be. All we — and they — can do is guess. But just as the commodities speculators are being blamed for $140-a-barrel oil — whether real problem is the lack of an energy policy — so now are short-sellers are being blamed for the problems Wall Street inflicted on itself.

Why isn’t the government investigating, say, Franklin Raines, the former chief executive of Fannie Mae, whose quest for rapid growth, and a higher stock price, had a lot more to do with Fannie’s current precarious state than anything any short-seller could possibly do?

So what does the SEC do? They pass an "emergency rule" - that ALREADY EXISTS!

“S.E.C. Chairman Christopher Cox said at a Senate Banking Committee hearing that the Securities and Exchange Commission would institute an emergency order requiring any traders to pre-borrow stock before shorting Fannie Mae and Freddie Mac, the embattled government-sponsored entities that own more than half the nation’s mortgages.” (Wall Street Journal news alert)

Too bad no one pointed out at the hearing that short-sellers already pre-borrow stock before shorting anything, not just Fannie and Freddie. And if they don’t, that’s called naked short-selling, and it’s against the law. (Just ask Patrick Byrne.) So why the emergency order? Oh, right. Because this is about chasing bogeymen, not getting to the root of any real problem.

We don't like the speculators BUYING assets and driving the prices up.... We don't like the short sellers SELLING assets and driving the prices down!!! What the fuck are we supposed to do!?!??! Look, I'm certainly not in favor of the deliberate spread of misinformation in order to manipulate stock prices - but that's not the definition of short selling.

Nocera is clearly as frustrated as I am with the blame game going on - from predatory lenders, to speculators, to short sellers - we keep trying to shift the blame, which is not going to solve the problem. I am especially troubled by this SEC "emergency rule" because they already passed such a rule several years ago! It's unlikely that this new "emergency rule" will be have any more impact than Reg SHO, which prohibits naked short selling (quick tutorial: when you short a stock, you basically try to sell high and buy low - the opposite of the normal buy low then sell high pattern. The catch is that you have to "borrow" the shares that you sell from someone - then you sell them, you hope the stock goes down, you buy it back, and you return it to the person you borrowed it from - who is no worse for wear. Naked short selling is when people sell stock they haven't borrowed, and it's already illegal except in very specific cases. Nocera's reference to Patrick Byrne is a great story of the OSTK CEO who claimed that short sellers were destroying his company.)

So why do I care if the SEC is re-passing a rule that already exists? Well, like the desperate attempts by the airlines to blame someone else for their own problems, the SEC is trying to convince the public that this will make a difference in the stock prices or the value of Fannie Mae, Freddie Mac, Lehman Brothers or anyone else - when in reality it's little more than desperate propaganda, and again, I fear, portends more ills to come.

Paulson and Cox can say that Fannie Mae and Freddie Mac will not need to use the government backstop that awaits them if they run into trouble - they might even believe it, but that doesn't make it true. We've gone through a massive period of leveraging over the last 15 years, and now we will go through a period of de-leveraging. It will take longer than 6 months -and I suspect the effects will be significantly greater than the rosy "not so bad" picture our financial leaders are trying to paint for us. And I didn't even mention IndyMac yet!

I had to laugh this morning as I flipped on CNBC and managed to catch some interesting testimony from Ben Bernanke's testimony before congress. Senator Jim Bunning from Kentucky had a phenomenal rant against the Fed:

“The Fed is asking for more power. But the Fed has proven they can not be trusted with the power they have. They get it wrong, do not use it, or stretch it further than it was ever supposed to go. As I said a moment ago, their monetary policy is a leading cause of the mess we are in…"

“Now the Fed wants to be the systemic risk regulator. But the Fed is the systemic risk. Giving the Fed more power is like giving the neighborhood kid who broke your window playing baseball in the street a bigger bat and thinking that will fix the problem. I am not going to go along with that and will use all my powers as a Senator to stop any new powers going to the Fed."

“Instead, we should give them less to do so they can do it right, either by taking away their monetary policy responsibility or by requiring them to focus only on inflation…"

“Let me say a few words about the GSE bailout plan. When I picked up my newspaper yesterday, I thought I woke up in France. But no, it turns out socialism is alive and well in America. The Treasury Secretary is asking for a blank check to buy as much Fannie and Freddie debt or equity as he wants. The Fed’s purchase of Bear Stearns’ assets was amateur socialism compared to this.” (emphasis mine)

Way to go Mr. Bunning - taking a hard line instead of cow-towing to your constituents and trying to placate them with soothing lies and witch-hunts for speculators, short sellers and predatory lenders.

We'll see how this all plays out...

-KD