Lehman: Short Raiders 1 : Regulators Nil

That is the score in the game of chicken played between the band of short sellers intent on pushing another Investment Bank over the brink and the regulators - in particular the SEC - who fiddle while Rome burns.
Last July the SEC imposed a ban on 'naked' short selling of bank shares which in our opinion was much too weak a measure given the pervasiveness of short selling and the fire power that the raiders have at their disposal. Naked short selling was illegal in any case, so to finally enforce it was just a pathetic gesture.
Financial Institutions are critically dependent on public trust as ALL banks would be bankrupt in a second if all depositors and creditors would demand repayment at any point in time. There was a time when short selling was limited to a small group of sophisticated investors and to market professionals such as NYSE specialists. Now this cottage industry has morphed into a monster that threatens the stability of whatever target the 'shorties' decide to take aim at.
Recent trading volumes in the shares of Lehman Brothers are so enormous that they cannot be simply the result of long-term shareholders deciding to sell. Activity in the shares is more akin to the frenetic buzz normally limited to betting shops. The SEC so far has failed to call an end to this and we fear that the taxpayer will have to pick up the bill when the music stops.
This shall not be construed to be a defense of the actions of Lehman management. That huge bets were made on property-related holdings is testimony to a serious lack of discipline on the part of top management.

Wipe out Fannie Mae Equity and profit handsomely!

Anyone who still has doubts about the ability of the authorities to deal with the fall-out from the sub-prime credit crisis would have been convinced otherwise if he had the chance to watch Bill Ackman pontificating about his proposal to 'recapitalise' Fannie Mae.
It is amazing that CNBC gives a fund manager who happily admits that he is short the common stock and subordinated bonds the platform on which to promote his financial self-interest at a time when the American Banking System (and British?) experiences a severe crisis of confidence.
At least the FSA in the United Kingdom has made a first step towards the restoration of fair play in the markets by making the practice of short selling shares in companies that are in the process of a rights issue subject to (very weak and ineffective) disclosure rules.

Short Selling is a valid practice - but like any good thing it becomes a danger if carried to extremes. Temple Associates is a fervent proponent of Free Markets but this practice can now be turned into a 'weapon of financial mass destruction'. Short Selling in the good old days was confined to market professionals (Jobbers or Specialists) and maybe a few savvy speculators who had very small amounts of money to play with. Now Short Sellers can muster billions, even tens of billions and as a consequence the practice has to be seen in a fresh light.
Short Sellers can initiate a vicious cycle and cause a downward spiral in confidence which is very difficult to reverse. Of course, where there is smoke there is fire. But that does not mean that a business that can be nursed back to health should be pushed over the brink just to satisfy the greed of a few market players.

Does the FSA have the right priorities?

We were recently trying to find the site where the FSA publishes the Disclosure Reports about Short Positions in the shares of companies that are staging a capital increase. The keyword 'disclosure' returns a staggering amount of entries from its website, more than a mere mortal can digest in a lifetime. But one item caught our attention. It is named 'Disclosure Requirements for the Accounts of Working Men's Clubs' (dated 4 July 2008) and runs to a full seven pages.
We did not know whether to cry or laugh about this gem that was penned by a faceless Civil Servant. With the whole structure of British Banking teetering on the brink, - do the regulators really have nothing better to do than concern themselves with the affairs of Working Men's Clubs? (by the way, we never met anyone who was a member of such a club and never heard that any such Club was causing major problems for the financial structure of the Kingdom).
Anyone who suffers too much stress in the markets and wants to relax for a moment can read the details on the FSA Website, Ref R/FS/AR 41D (and lest I forget, there are Notes attached!)

Compensation: what now for cash vs stock split?

Some recent commentators have predicted that in the future the Securities Industry will pay a higher proportion of total compensation in the form of shares and options in order to stimulate a more risk-conscious behaviour pattern among staff. While this may sound plausible it does not necessarily make sense for the majority of employees in a securities firm.
Why should the government bond trader whose P&L is clearly visible at the end of each day and whose book does not contain any long-term risks be paid in instalments that only become due many years after he has produced the goods?The recent - and ongoing collapse - in the share prices of most brokerage firms and banks is in the majority hitting employees who did not have any influence on the poor decisions made by the senior management of those firms. To add insult to injury one could say that the top executives who have been asked to leave have done much better than those employees that are left behind and have to suffer the consequences of a rapid decline in the value of their company stock or share options that the ineptness of the departing senior managers has caused.

Kerviel Case: Where has all the money gone?

In all the excitement about the huge losses made by Soc Gen's Monsieur Kerviel and the bank's management one thing never gets mentioned: someone out there has made a whopping big profit out of all of this. Futures in particular are the ultimate zero sum game and where there is a loss there always is a profit. This is no consolation for Societe Generale and its shareholders who are left holding the proverbial bag but it should calm the nerves of politicians, economists and other commentators. Economically not much has happened except that a substantial sum of money has passed hands. Society as a whole is not poorer as it would be if the same sum of money would have been spent building pyramids - or steel plants that turn out to be surplus to requirement once they are finished.

Northern Rock - two key questions that need to be answered

The first question - and it has hardly been receiving attention in all the discussions of the Northern Rock saga that we are aware of - is the question of how it can be that in a so-called 'democracy' emergency legislation can be passed where the executive and legislative branches of government are in collusion and decide to 'nationalize' private property. The emergency support that the German Government has just decided to give to IKB Deutsche Industriebank in Germany (thanks to an obliging taxpayer that has no say in these arbitrary spending decisions) is just a less blatant form of nationalisation (where private wealth is taken away from its rightful owners and spent by politicians to spend on their favored constituencies).

The second question is again an indictment of Government, more specifically the quasi-governmental agencies that masquerade as 'banks' and are more commonly known as 'Central' Banks. In recent months untold (literally) billions of confetti money have been spent by these curious 'banks' in providing liquidity to the World's Banking system. No one will deny that Northern Rock used the leeway that is given by banking regulations to an extent that could with some justice be described as imprudent. But this is no excuse to provide all other banks with liquidity but let this particular bank hang out to dry. This was the crucial decision (mistake?) taken by the authorities back last summer and that has to be the point of departure when assessing the correct compensation for the Northern Rock shareholders. It simply is not good enough to destroy a business first and then base compensation on the situation that has been created by one's actions.

Non-Dom Taxes - Nail in the Coffin for London's City?

Ill-conceived taxes were instrumental in the development of the Eurocurrency and bond markets during the late 1960s and early 1970s. First the American Government in its wisdom introduced the so-called Interest Equalisation Tax in 1963 in order to make it more expensive for non-US borrowers to access the US capital market. Then the Swiss authorities levied penal tax rates on transactions involving Eurobonds and other securities. As a consequence, most business involving international securities decamped to London during the 1970s. Now Gordon Brown has decided to make his own mark on the history of the Euromarkets by introducing a special levy on foreigners involved in the international capital markets. Not only is the per-capital levy of £30000 per person highly arbitrary and unfair but the detailed regulations introduced are so complicated and wide-ranging as to provide the proverbial straw that breaks the camel's back. The London City should take note that in the intervening years the authorities in Switzerland and the USA have learned a lesson or two and that financial institutions - once gone from the City of London - are unlikely ever to return again.

Exit 'Fred the Shred'- Character traits in Chief Executives

We have never personally met Fred Goodwin but reading an article about him we were reminded that many corporate disasters happened under the leadership of executives that were described as domineering. Whatever the merits of this adjective in Goodwin's case - any analyst worth his salt should scan press articles for similar key words and have a good second look at any business that is run by someone described with these words.

To Quant or not to Quant?

Yesterday's Financial Times carried a polemical piece by Nassim Taleb. In it he derided the use of mathematical models and called the so-called Nobel Prize for Economics an absurdity.
While we ploughed our way through a fair share of mathematics in our undergraduate economic classes and found them pretty remote from reality, we would not go so far as to completely reject the role of mathematics in the financial markets. At that time it was a sign of stellar quant ability if a bond trader or salesman could calculate the yield to maturity on a bond without use of a calculator, but time has moved on.
The recent events in the credit markets, however, have demonstrated that at PhD in Maths cannot be a substitute for good judgement and that good character should still be the basis for a successful career and business.

Bonus Fears: Not as bad as the headlines make believe

Some newspaper headlines predict massive job losses and a substantial drop in bonuses for financial market professionals this year. Apart from creating a bit of publicity for some of our competitors who are quoted by the media we advise clients and candidates to keep a cool head and focus on the big picture.Excessive discussions about the expected level of bonuses are a nuisance in the best of times and for many firms the year is only over on 31 December. So there is still a lot to play for. Emerging Markets are booming (too much?), and fund-raising continues at a frenetic pace in the alternative investment field.