Bear squeeze blues: How to destroy a bank
Set phasers to 'short sell'
Comment With the banks apparently unable to cope with the markets anymore, the poor dears, short selling has been banned to protect them. HBOS is being taken over cheaply, even compared to what a mortgage bank is worth in this rotten market. Allegedly, "spivs" conducted a whispering campaign, and used short selling to make money out of misery. It is nearly true.
If you had known in advance that Northern Rock was doomed, you could have made real money. But insider dealing wouldn't have helped you since the "insiders" didn't seem to know what was going on until it was too late. The Lehman collapse seems to have been partly caused by executives refusing to take a catastrophic write-down in their personal wealth, betting that they were too big to fail. So inside information here would have been hard to use.
Of course, if you cause the bank to go down, then you have the most perfect of insider information - so how would you do that?
Short selling is just a bet that the price will decline; you sell stock you don't yet own, and hope that when the time comes to deliver, the price will be lower. Outside the markets it has few friends, although it is a critical component in getting better returns on money for lower risk. A traditional bet on a horse does not make it run faster, at least in an honest race, but every part of a company's financial profile interacts with the others.
Hedge funds have made respectable money shorting financial stocks and using the proceeds to go long on energy shares, at lower risk than simply buying shares in oil companies. The greater risk efficiency of HFs is the reason that on average they have grossly outperformed "long only" traditional fund managers - and as any student of finance will tell you, the only consistent performance is under-performance. And yes, before you ask, that is where a large chunk pension of funds are invested.
As banks don't sell beer...
Every company has a set of credit ratings; how likely it is to default on its debts in a given range of time. The longer you lend money, the more exposed you are to a default, and so there is often an extra premium for lending for the longer term than for shorter periods. The core job of any bank is to do just this. Banks borrow in the shorter term, sometimes literally overnight, and lend over years. Without this we could not have mortgages, or finance infrastructure projects where there is no revenue from the investment for as much as ten years.
The greater the difference in time between how long you lend for and borrow, the more money you make, on average. However, with this greater return comes greater risk, which Northern Rock simply ignored.
When an individual lends money to a bank in a deposit account, they enjoy government guarantees, which commercial lending usually did not, so the NR debacle started when became clear that if you lent money to NR, the chances of getting it back were dropping sharply. NR was exploiting the short term money markets, and although even the FSA spotted the high risks involved early, it didn't want to annoy them - so the banks ignored it until this hit them in the face. Short-term markets are of course a bad place to be when you suddenly find yourself without enough cash to pay what you owe in the longer term.
If you happened to have a short position in NR early enough, you did pretty well - but few did. Still, the idea was clear enough - if a bank is perceived to be on the slide, the next dip in the stock can actually be caused by the most recent downtick.
The next villains in this mess are the ratings agencies. Their job is guessing the odds of a debtor not paying back debts, whether that is bonds, or payments to suppliers. This is an eclectic mix of accountancy and PhD-level mathematics, though of course it is mostly done by MSc-level people at ratings agencies, trying to vet the maths of PhDs. Guess how well that ends? The MScs are not only cheaper than PhD Quants, they ask fewer awkward questions. The agencies are paid by the issuers of debt instruments to give them a rating which is critical to the value when they are sold. Yes, you read that correctly.
Where were the controls?
[This turned out to be a rant. You're free not to read it]
I'm amazed by the synchronicity of event in UK and US. It started with politics: both sides attarcted "leadership" which emerged rather quickly not to be too bothered about reality as long as it didn't interfere with their chums emptying the trough as fast as they could now they finally had the chance. Both sides relied extensively on spin, lies and as little transparency as they could get away with (whilst claiming to fight for the opposite, of course) and as much abuse of the nation's controls as they could muster (look up "bush signing statements" if you want to see just how much an alleged democracy was turned into something else entirely by Bush).
The rest is textbook stuff. Use or stage a calamity to scare the population into being quiet, destroy living conditions and schooling so that the average voter is far too busy surviving to think and keep it going for as long as possible. Cooking up a war is also a good way to push some tax revenue into the hands of the small cabal who sell weapons without too many objections, it's "fighting EVIL", innit?
That also needed hollowing out regulatory control. Start checking just who exactly limited the regulatory budgets. Who ensured the competent people disappeared? If you think only rating agencies employ cheap staff, you should look at the UK National Audit Office who drafts in consultancies, who (obviously clever enough not to derail the gravy train) employ the most junior people for investigations. The advantage of juniors is that they can also be overruled very easily, in the unlikely case they would see through some of the scams at, say, the ID Card project. The strategy worked, and where it threatened to fail, key people were given new jobs, designed to compromise them enough to make sure they wouldn't speak up either. It's everywhere. Health, military, finance - no wonder both nations have almost gone to the wall.
Here's a simple question: does anyone remember just where T Blair went to work, and how well they have done out of the crisis? If that surprises you you haven't been cynical enough, and you may take this as a hint that the crisis wasn't so unexpected as it appears (OK, we're now in conspiracy land, but you must admit that coincidences stack up in a staggeringly convincing way).
The trough is almost empty now. A last moment effort chalked up another loan on the tax payer's bill ($700bn, "because it's a nice big number") so that the bad players can escape in luxury with a nice pension, probably to another country. I wonder what this in the UK will look like, but the players are already positioning, including the returned master of spin, Mandelson, who will probably be tasked with explaining that it wasn't the government's fault and that a more active celebration of Guy Fawkes' day to get some people to take personal responsibility won't help (mainly because they have already retired to another country).
What these people have done amounts IMHO to treason. There is no other word that comes close to describing the full scale of what they have been doing for the last 8 years, and the misery that they have caused by their selfish behaviour. This was really treating people like money producing cattle.
I'll have my coat now, thanks, I have a plane to catch. The last one out doesn't need to bother turning off the light.
The lights will go out all by themselves.
Short sellers = Scape goats
Short sellers are being made scapegoats in whole of this debacle. Why did short selling take out all institutions one by one. They work on information not assumptions. The total shortfall with UK banks is 650 Billion in outstanding obligations. This is = to approx 50 Billion Pm.
The system is not generating anywhere near 50 billion per month. As cheap money is not available to repay these obligations unless govt gives banks money the situation will get worse.
"5 banks went titsup today. (Fortis, Glitnir, B&B, Wachovia, Fortis). "
That would be four banks then. And I'm not sure I want to trust your maths on anything else.