Hedge Funds May Have Gone Too Far

by: Trader Mark September 18, 2008 | about stocks: GS / MS    
Trader Mark

Trader Mark

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I honestly think the hedge funds did a brilliant job of their sole purpose - maximize profits - in this era. Even if some of their tactics are disgusting. They played the game to perfection. They know the ratings agencies after taking so much heat now shoot first, ask questions later. They know the rating agencies recently begun taking stock price into consideration of their ratings (which is ludicrous - so that means ABC.com in 1999 deserves an AAA rating?) They know by buying up CDSs they can create a panic, which drives down the stock price, which causes the rating agency to downgrade, which leads to a death spiral.

They found the loopholes. But I think they took it one step too far. You simply do not attack Goldman Sachs (GS). Goldman has too many people placed in government. CNBC said Thursday morning, Morgan Stanley (MS) CEO was livid Wednesday and had the ears of people in various arms of the government (he was once considered for SEC commissioner) - essentially if Morgan Stanley goes down, this is blood on your hands. In the end it still comes down to who you know. And I think the government is now fully engaged. Again, I think some weak companies (i.e. Franron - I stole this term but I love it - that would be Freddie/Fannie/Enron for newbies) should go to zero but when stock price action clearly has disassociated from fundamentals you no longer have a "fair" market. And this was finally registering by those who matter and can change the rules. Again the irony is the traders at these investment bank firms have benefited from the rules for a long time - only when their Frankenstein partners turned on them did they realize the other side of the trade.

The SEC has been a total disaster but they finally are enforcing a rule on naked short selling they have had on the books since 04 I believe. It's a disgrace what has been done to small company after small company by hedgies who can attack them relentlessly because they are too small to defend themselves. But now that they've targeted the big fish - Goldman - it's going to change. Another thing you might hear a lot is bring back the "uptick rule" - this was taken away a year ago... it was "stress tested" in a bull market - duh. Basically this means you need to wait at least for a "tick up" in the stock price before you can reshort. Frankly I think in this era of quant hedge funds and computer trading the uptick rule is now rendered useless. Let's say I want to short the stock into the ground - these super computer (I am being serious) can put in thousands of trades a minute - all it takes is an alternating system of sell short, then buy 1 share on the upside, sell short, buy 1 share on the upside. Etc. These are some of the brightest minds on earth many with PhDs in the sciences - they can figure it out. So that's a non starter.

However, there are potential game changers on the horizon. This would be a huge one and in fact I am blown away they would consider it. The whole idea of hedge funds is secrecy and being hidden away from regulation. They have to file their positions quarterly like a mutual fund. But only their long positions - I've always wondered why not their short positions? That was a major issue. But even then, in this current era - if you were attacking a stock in a pack - all you would have to do is lift your shorts by the end of day 4 PM on March 31, June 30th, Sep 30th and Dec 31st and no one would know what you were doing (those are your end of quarter dates) But now the pendulum has swung so far - again this is amazing - the SEC is considering rules that hedge funds over $100M in size have to release their short positions DAILY. That's simply a seismic shift if it happens. Because this takes away the entire idea of the secrecy of positions.

Once more - don't mess with Goldman Sachs. They simply are too intertwined with US government. As with all things, in the pursuit of greed - people crack the golden egg. If this rule passes, it simply changes the game.

  • The U.S. Securities and Exchange Commission may require hedge funds to disclose their short-sale positions and plans to subpoena the funds' communication records in an effort to stem turmoil in stock markets.
  • Hedge funds and investors managing more than $100 million in securities would be ``required to promptly begin public reporting of their daily short positions,'' Chairman Christopher Cox said in a statement late yesterday. The agency will obtain ``disclosure from significant hedge funds'' regarding ``past trading positions in specific securities,'' Cox said.

  • Lawmakers including U.S. Senate Banking Committee Chairman Christopher Dodd and executives such as Morgan Stanley Chief Executive Officer John Mack say short sellers may have contributed to the market crisis by spreading false information and using abusive tactics to attack companies. Hedge funds argue that poor business strategies are to blame, not short sellers.

  • ``A lot of hedge funds don't like being forced to disclose their long portfolios, so they're really not going to like this,'' said Sean O'Malley, a former SEC lawyer and now a partner at Goodwin Procter LLP in New York. ``There is going to be some push back from hedge funds, but they may not get any sympathy in the current market environment.''

Folks, this is going to be very interesting to watch play out and I can bet you a lot of people are quaking in their boots in NYC and Connecticut. I've said someone is going to go down for this in the past - they will find people - those in cahoots and working together to bring down the Lehmans, Bears, Fannie, Freddies - they will find someone not named Martha Stewart.

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This article has 10 comments:

  •  
    Sep 18 03:44 PM
    Cox and Rubin's buddies at Goldman and MS are being attacked and all of a sudden there is some hype that the regulations will be enforced. On their own, the fed and treasury could do nothing, but add the NY ATTorney general and the British looking into short selling, and the inside boys are worried and want to comply. What a lousy system for the average investor. Some of these culprits, in government and in the hedge funds should go to jail and be forced to give up their ill gotten gains.
    Reply | Link to Comment
  •  
    Sep 18 03:59 PM
    Good article. Sad to say the government has always operated by one set of rules for them and another set of rules for us. I think it's great that the SEC is finally moving against naked short selling a.k.a. fraud.
    Reply | Link to Comment
  •  
    Sep 18 05:00 PM
    Disclosing short selling is going to put many hedge funds out of business. You aren't going to be able to talk to the management of companies if they know you are shorting their stock. I am talking about legitimate market neutral funds who aren't manipulating the markets.

    There should be more regulations for short selling, but make them reasonable so that shorting can still be used legitimately. The problem is with manipulation, not shorting.
    Reply | Link to Comment
  •  
    Sep 18 11:00 PM
    Sympathy for the Shorts
    (Lyrics by WilliamBanzai7)

    Please allow me to introduce myself
    Im a man of wealth and taste
    Ive been around for a long, long year
    Stole many a mans nest egg and faith
    And I was round when Livermore
    Had his moment of doubt and pain
    Made damn sure that Milken
    Washed his hands and sealed his fate
    Pleased to meet you
    Hope you guess my name
    But whats puzzling you
    Is the nature of my game
    I stuck around AIG
    When I saw it was a time for a change
    Fired the CEO and his SVPs
    While Bernanke screamed in vain
    I killed a bank
    Was best friends with Hank
    When the markets raged
    And the cold Pizzas stank
    Pleased to meet you
    Hope you guess my name, oh yeah
    Ah, whats puzzling you
    Is the nature of my game, oh yeah
    I watched with glee
    While your investment banks bleed
    Fought for ten decades
    To kill paper they made
    I shouted out,
    Who killed the GSEs?
    When after all
    It was you and me
    Let me please introduce myself
    Im a man of wealth and taste
    And I laid traps for bankers
    Who get fired before they reach Mumbai
    Pleased to meet you
    Hope you guessed my name, oh yeah
    But whats puzzling you
    Is the nature of my game, oh yeah, get down, baby
    Pleased to meet you
    Hope you guessed my name, oh yeah
    But whats confusing you
    Is just the nature of my game
    Just as every banker is a criminal
    And all the investors saints
    As heads is tails
    Just call me hedge fund joe
    cause Im in need of some restraint
    So if you meet me
    Have some courtesy
    Have some sympathy, and some taste
    Use all your well-learned risk controls
    Or Ill lay your trading book to waste, um yeah
    Pleased to meet you
    Hope you guessed my name, um yeah
    But whats puzzling you
    Is the nature of my game, um mean it, get down
    Woo, who
    Oh yeah, get on down
    Oh yeah
    Oh yeah!
    Tell me baby, whats my name
    Reply | Link to Comment
  •  
    Sep 19 12:52 AM
    I think, if you look, the rule about "naked short" selling has been around since 1935. I hope to God that this little bout of market panic finally kills the Repub idea that all regulation and market oversight is BAD. Next on the list would be to kill off this insane idea of "Supply Side" (only) economics.
    Reply | Link to Comment
  •  
    Sep 19 02:05 AM
    If the this latest market insanity hasn't proven that the Republican mantra "free markets above all" isn't a sham, I don't know what will.

    Who's your daddy now, Mr. Republican? It ain't the free market. It's the FED!
    Reply | Link to Comment
  •  
    Sep 19 09:44 AM
    Well, yes, it is unfair that the big boys at GS, MS andat many other enteprises have the clout to get protection for themselves, while they have been guilty of practises of the same kind in behalf of their clients and their own accounts in the past. But this is not a fair world, and was probably never meant to be. However, nore important, somebody should have had the gumption to call for the firing of Christopher Cox a long time ago. McCaine has finally done it yesterday -- too late and perhaps only because he is running for election and Cox has been one of the sore points in this election. In my view, it is a fault to appoint anyone who has served in Congress or the Senate to a post in a business related field, such as as the SEC or the Board of a financial public enterprise. Political sense is simply in conflict with dollar and cent propriety too often and in strange ways.
    Reply | Link to Comment
  •  
    Sep 19 03:10 PM
    Don't forget the history of giving mortgages to people who can't afford a downpayment. In 1977 Congress passed the Community Reinvestment Act trying to force banks lend to these people. Banks were ranked by the communities they served and eventually were forced by four government regulators and Congressional Pols, mostly Democrats to lend to poor people. Then Clinton finished it off in 1995 with a revision to the act which further coerced lenders. It also created a new class of securities, Mortgage Backed Securities. Using them, banks giving mortgages could cobble a whole bunch of them together and sell them in the secondary market to investors all over the world. This made it very profitable for mortgage originators to issue lots of mortgages because they could be sold so easily to investors.

    There were lots of groups reporting on what banks were doing and lobbying Congress, one of the largest being Acorn which taught Obama how to be a community organizer helping poor people get mortgages and other help.

    So Congress and the government and the lobbyists created the whole crisis by creating Mortgage Backed Securities and by literally pummeling financial institutions to lend to the poor, those who could not
    afford 20% down or anything down? And once MBSs were created, mortgagors had a way to unload what they knew to be high risk paper to investors thus making them more willing to make those mortgages and satisfy Congress.

    Best regards, Ben
    Reply | Link to Comment
  •  
    Sep 19 09:41 PM
    The bottom line is the bankers got rich writing crappy mortgages, and there was no reason for them not to. Nobody is going to claw back the millions they got paid in bonuses for creating a trillion dollar mess.

    Next question -- now that nobody can short the "sacred 799", is there any provision preventing those banks' insiders from selling into this government-mandated short squeeze? As Lincoln said, "you can fool some people all of the time..." The house always wins. ;)
    Reply | Link to Comment
  •  
    Sep 20 12:02 AM
    From The Soundtrack : Ghostbusters (1984)


    SHORT Busters…


    If there's somethin' strange on your balance sheet
    Who ya gonna call (shorttbusters)
    If it's somethin' weird an it don't look good
    Who ya gonna call (shortbusters)

    (Lehman) I ain't afraid a no shorts
    (AIG) I ain't afraid a no shorts
    If you're seein' CDO's ruinin' your networth
    Who can you call (shortbusters)
    An' invisible trade dragging down your spreads
    Oh who ya gonna call (shortbusters)
    (Merrill) I ain't afraid a no shorts
    (Bear) I ain't afraid a no shorts
    Who ya gonna call (shortbusters)
    Morgan Stanley: If you're all alone pick up the phone
    An call (shortbusters)

    (Paulsen) I ain't afraid a no short
    I hear it likes Goldman
    (Goldman) I ain't afraid a no shorts
    Who you gonna call (short busters)
    Mm…if you've had a dose
    Of a naked short baby
    You better call short busters
    (SEC Cox) Bustin' makes me feel good
    (Bernanke) I ain't afraid a no shorts
    Reply | Link to Comment
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