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Get Shorties

Anger at short-sellers is totally understandable. But the only thing that can really stop them is a full-fledged market recovery.

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Illustration by Matt Dorfman  

If a couple of hedge funds wanted to destroy Lehman Brothers, just wipe the company off the face of the Earth, no matter how storied and how well managed the place has been over the years, they could do it in a week’s time. Maybe, given the precarious state of this stock market, they could assassinate Lehman Brothers overnight.

Mind you, the blueprint I am about to present doesn’t work against every firm; it just works against every financial firm that has lost credibility by insisting that it is doing well and then failing to disclose that it hasn’t been. That was Bear Stearns’ real flaw, and it is Lehman’s too. If you were to listen to Lehman’s comments about how well it’s been doing in the last year, until very recently, and contrast them with reports from Goldman Sachs, you would have thought that Goldman was on the ropes and Lehman was performing swimmingly. If you didn’t look at the share count, you would think that Lehman had to be taking advantage of its declining share price and buying its stock as Goldman was sidelined and hobbled. Of course, the opposite is true: Goldman has been reporting monster good quarters, but it tries to disclose every single misstep and flaw in its portfolio while buying back stock hand over fist because it’s so flush with capital. Lehman has been hemorrhaging cash as it financed a horrid portfolio of toxic mortgage paper both from here and in Europe and doesn’t have a cent to retire stock; it’s too busy issuing more of the stuff.

In retrospect, it was so easy to take down Bear. As the mortgage crisis began, Bear’s own hedge funds and its investment arms were among the biggest creators, purveyors, and ultimately buyers of the worst “no doc” mortgage securities, which are defaulting at a frightening rate. At the same time, its CEO, Jimmy Cayne, chose to sharpen his already excellent bridge game as the firm burned. At least he had some friends on the Street, and if he had focused on business and clients, he might have had an idea how rogue an outfit he had on his hands and could have rallied his many colleagues for help. But when he was fired and a new man, Alan Schwartz, came in from the investment side, not Cayne’s trading side, hedge funds lacked any loyalty at all toward the guy. Bear was a tremendous repository of hedge-fund money and leveraged itself mightily so it could lend to clients and finance its own bulging mortgage inventory. All the hedge funds had to do was sell Bear stock short in huge amounts, pull their money out of the firm, and tell everyone how worried they were about Bear’s solvency. Money both talked and walked, and in a few days Bear was gone, a victim of extreme mismanagement, ignorance, smugness, arrogance, and recklessness.

Lehman, long run by Dick Fuld, as respected as Jimmy Cayne before he took his intellectual leave of absence, shares too many of these same qualities. It has borrowed way too much, issued way too many bad mortgages, kept way too many of them, bought way too many of them from clients, and had equally wretched controls. So now the hedgies are performing the same drill on Lehman they did on Bear. Given that Lehman has repeatedly had to raise money to finance its miserable mortgage portfolio, as well as some crummy private-equity investments that need commercial real estate to appreciate—good luck!—the company can’t mount a credible defense. Gone are the days when Fuld could pick up the phone and say, “I bid $31 for 1 million shares of Lehman,” as he did to me in 1998 to quell that raid on his firm in the wake of Long Term Capital’s demise.

Ironically, Lehman has been at the forefront of making the actual exercise of crushing stocks, including its own, as easy as pie. When Congress created the Securities and Exchange Commission, it held hearings that determined that short-sellers played a key role in destroying stocks by colluding to push them down with sell orders, known as bear raids. The SEC authorized a powerful check on such raids: You had to wait for a “plus tick”—meaning there is a buyer willing to pay a higher price than the last sale—if you wanted to short the stock. The uptick rule served as a decline breaker. Short-sellers had to wait patiently for buyers to emerge. Last year, the SEC got rid of this rule, saying it was obsolete because it could be so easily circumvented with options and other derivatives. The result is that hedge funds are crushing stocks simply by endlessly selling them down, blitzing buyers, and sowing fear, just like the Depression-era activities that begat the rules. Hedge funds aren’t allowed to collude, but they all share the same playbook, so they collectively can carpet bomb a stock and feed the impression that a firm is in jeopardy. The bears have repeatedly raided Lehman’s stock this way, scaring off potential buyers. When, behind the scenes, I have urged major brokerage firms to help me on a crusade to restore the uptick rule, I met with the strongest resistance from none other than Lehman. Management found the rule atavistic and didn’t think it mattered at all.


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