Naked short-selling bringing down Lehman? Not even a funny joke and astounding that even allegedly financially-savvy WSJ/Bloomberg would debate the stance.
Arguing that short-sellers killed off Lehman is akin to the following: a man is assailed by a group of thugs (bankers/credit agencies) and shot four times in the head, and three times in the heart. He falls down, seconds away from certain death. A second man (naked short-seller) comes up and kicks the dying man in the arm. Rude? Possibly. The murderer? No.
Ritholz couldn't have nailed it better:
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From Barry Ritholtz's The Big Picture
Both the WSJ and Bloomberg have articles this morning about Naked Shorting. The Bloomberg article more explicitly suggests that Lehman was “brought down,” in part, by naked shorting:
Naked Short Sales Hint Fraud in Bringing Down Lehman
“The biggest bankruptcy in history might have been avoided if Wall Street had been prevented from practicing one of its darkest arts.
As Lehman Brothers Holdings Inc. struggled to survive last year, as many as 32.8 million shares in the company were sold and not delivered to buyers on time as of Sept. 11, according to data compiled by the Securities and Exchange Commission and Bloomberg. That was a more than 57-fold increase over the prior year’s peak of 567,518 failed trades on July 30. The SEC has linked such so-called fails-to-deliver to naked short selling, a strategy that can be used to manipulate markets. A fail-to-deliver is a trade that doesn’t settle within three days.”
This is one of those things that is easy to allege, hard to disprove, has coincidental supporting data, and provides just enough plausability to make people forget (albeit temporarily) the cold hard facts of the day.
If I were at Bloomberg, here is how I would have written this article:
Over-Leverage, Under-Capitalization Brings Down Lehman (Update)
“The biggest bankruptcy in history might have been avoided if Wall Street had been sufficiently capitalized, used only moderate leverage, and avoided making false assumptions in their econometric models.
As Lehman Brothers Holdings struggled to survive last year, it was using as much as 40 to 1 leverage to purchase AAA securities that turned out to be no where near as safe as the triple A ratings assigned to it by Moody’s and S&P made them appear. Lehman, the second largest securitizer and trader of mortgage backed securities behind the also defunct Bear Stearns.
Wall Street continued practicing one of its darkest arts — the over rating of securities, bonds and derivatives — by self-interested parties in exchange for fees. In the 1999-2000 tech boom, the analyst community vastly over rated stocks with “Buy” and “Strong Buy” ratings. Sell wa hardly in their vocabulary. These were mostly profitless “dot com” companies built on the merest of concepts. The underwriting fees were substantial, however, and the analysts firms were well paid via large syndicate and IPO banking fees.
The same conflict of interests remained on the Wall Street, even after the dot com collapse. This time around, it was the ratings agencies — Moody’s, S&P, and Fitch — that slapped triple A grades on paper that turned out to be junk in exchange for huge fees from the underwriters.
The SEC has yet to seriously investigate how and why so many triple A rated issuances have collapsed and failed. These highly rated papers are linked to “payola” ratings, a practice that involved Ratings Agencies selling their highest seal of approval in exchange for large fees.”
When we were short Lehman at the time, from $30 and higher — it was an easy borrow, and there was no need for anyone to short naked. That was not why they went bankrupt.
My biggest regret about Lehman Brothers — aside from all the unfortunate souls who lost their jobs when the company imploded — was that I lacked the cojones to buy a big slug of Puts when we went short . . . They seemed kinda pricey at the time.
If Warren Buffett's prediction proves to be correct --once the economy bounces we will have no choice but to inflate ourselves out of the hole, and subsequently head to inflation worse than the 1970s-- then the following article will be of interest. Bookmark it and go back to it in a few years :-)
To summarize in a few words: buy gold, commodities, Swiss Francs, and TIPS (Treasury-Inflation-Protected-Securities) to protect your portfolio against being decimated by inflation.
What's our opinion: there will be some kind of co-ordinated effort to wade off inflation considering China owns over 1 TRILLION of our debt. You don't want to bite off the hand that feeds your spending habits.
By Eric J. Fry
The flaming embers of inflation have already landed atop the thatched roof of American finance. And yet, investors can still buy inflation insurance on the cheap. In the next 1,373 words, we’ll examine a few of these “insurance policies”to assess their virtues and drawbacks.
Since a powerful new inflationary trend is very likely to occur, the prudent investor should probably take steps to guard against it. “But wait a second!” some readers be saying. “What if a powerful deflationary trend occurs first?”
Good question. It might. But we’d begin preparing for inflation anyway. Why not prepare for the near-certain arrival of inflation, rather than the uncertain timing of it.
If an infallible clairvoyant told you that your house would burn down in one of the next five years, would you say to yourself, “Gosh, maybe I should try to figure out which year it will be and not buy fire insurance during the other four years.”
You might actually guess correctly, in which case you would have saved yourself four years worth of insurance premiums. But you might guess incorrectly, in which case you would have lost your house.
Your call.
To this market observer, inflation seems like a near-certainty. Not an absolute certainty, mind, you, just a near-certainty, sometime within the next three years. So why not beat the rush to buy inflation insurance? Why not buy some now?
The nearby chart displays a sampling of inflation hedges, and how they performed during the last eight years of the infamous 1970s. Gold was clearly the standout winner. But we’d put an asterisk next to this result, due to a performance-enhancing assist from the U.S. government. During most of the preceding four decades, the US government had been artificially suppressing the gold price, while also forbidding private citizens from owning it. Therefore, once the government stopped its meddling, the gold price partied like a teenager whose parents had just left town.
Aside from gold, very few assets managed to keep pace with inflation, as measured by the Consumer Price Index (CPI). Hard assets like the CRB index of commodity prices and the Swiss franc did outpace the CPI, but stocks and bonds both lagged miserably.
Skipping ahead about 30 years, we can see that the modern versions of the 1970s inflation hedges have performed quite poorly during the last 14 months. Clearly, inflation is not a widespread concern. But that’s part of the reason it concerns us, and also part of the reason why we’d be inclined to take action now, while inflation hedges remain relatively cheap.
Our contrarian instincts lead us –rightly or wrongly – to distrust the consensus, especially when the consensus trusts in an idea as stupid as deflation…just kidding. We don’t think deflation is stupid, just unlikely. (More precisely, we suspect that deflationary indicia will be seasonal, like daffodils. For a while, they will seem to be everywhere. Then, just as suddenly, you won’t be able to find a single one).
So with that biased and unscientific preface, let’s sweep through a Reader’s Digest review of ETFs that might provide some kind of hedge against inflation:
Crude however had a nice move on Friday (Feb contracts expired) and if we get continuation this week we could be looking at bottoming action.
Term Structure of Crude Oil Futures Prices and the Impact on Total Returns
One factor that impacts the total return that will result in investing in near month crude oil futures contracts and ‘‘rolling’’ those contracts forward each month is the price relationship between the current near month contract and the next month contract. For example, if the price of the near month contract is higher than the next month contract (a situation referred to as ‘‘backwardation’’in the futures market), then absent any other change there is a tendency for the price of a next month contract to rise in value as it becomes the near month contract and approaches expiration. Conversely,. Several factors determine if the price of a near month contract is lower than the next month contract (a situation referred to as ‘‘contango’’ in the futures market), then absent any other change there is a tendency for the price of a next month contract to decline in value as it becomes the near month contract and approaches expiration.As an example, assume that the price of crude oil for immediate delivery (the ‘‘spot’’ price), was $50 per barrel, and the value of a position in the near month futures contract was also $50. Over time, the price of the barrel of crude oil will fluctuate based on a number of market factors, including demand for oil relative to its supply. The value of the near month contract will likewise fluctuate in reaction to a number of market factors.
If investors seek to maintain their holding in a near month contract position and not take delivery of the oil, every month they must sell their current near month as it approaches expiration and invest in the next month contract.
If the futures market is in backwardation, e.g., when the expected price of oil in the future would be less, the investor would be buying next month contracts for a lower price than the current near month contract. Hypothetically, and assuming no other changes to either prevailing crude oil prices or the price relationship between the spot price, the near month contract and the next month contract (and ignoring the impact of commission costs and the interest earned on cash), the value of the next month contract would rise as it approaches expiration and becomes the new near month contract. In this example, the value of the $50 investment would tend to rise faster than the spot price of crude oil, or fall slower. As a result, it would be possible in this hypothetical example for the price of spot crude oil to have risen to $60 after some period of time, while the value of the investment in the futures contract will have risen to $65, assuming backwardation is large enough or enough time has elapsed. Similarly, the spot price of crude oil could have fallen to $40 while the value of an investment in the futures contract could have fallen to only $45. Over time if backwardation remained constant the difference would continue to increase.
If the futures market is in contango, the investor would be buying next month contracts for a higher price than the current near month contract. Hypothetically, and assuming no other changes to either prevailing crude oil prices or the price relationship between the spot price, the near month contract and the next month contract (and ignoring the impact of commission costs and the interest earned on cash), the value of the next month contract would fall as it approaches expiration and becomes the new near month contract. In this example, it would mean that the value of the $50 investment would tend to rise slower than the spot price of crude oil, or fall faster. As a result, it would be possible in this hypothetical example for the price of spot crude oil to have risen to $60 after some period of time, while the value of the investment in the futures contract will have risen to only $55, assuming contango is large enough or enough time has elapsed. Similarly, the spot price of crude oil could have fallen to $45 while the value of an investment in the futures contract could have fallen to $50. Over time if contango remained constant the difference would continue to increase.
Historically, the oil futures markets have experienced periods of contango and backwardation, with backwardation being in place more often than contango. During the previous two years, including 2006 and the first half of 2007, these markets have experienced contango. However, starting early in the third quarter of 2007, the crude oil futures market moved into backwardation. The crude oil markets remained in backwardation until late in the second quarter of 2008 when they moved into contango. The crude oil markets remained in contango until late in the third quarter of 2008, when the markets moved into backwardation.
While the investment objective of USOF is not to have the market price of its units match, dollar for dollar, changes in the spot price of oil, contango and backwardation have impacted the total return on an investment in USOF units during the past year relative to a hypothetical direct investment in crude oil. For example, an investment made in USOF units made during the second quarter of 2007, a period of contango in the crude oil markets, decreased by -0.71%, while the spot price of crude oil for immediate delivery during the same period increased by 7.30%. Conversely, an investment made in USOF units during the third quarter of 2007, a period in which the crude oil futures market was mostly in backwardation, increased by 17.82% while the spot price of crude oil increased by 15.53% (note: these comparisons ignore the potential costs associated with physically owning and storing crude oil which could be substantial).
