Thursday, July 13, 2006

What Makes the Hottentot So Hot?


What makes a king out of a slave? Courage! What makes the flag on the mast to wave? Courage!

What makes the elephant charge his tusk in the misty mist, or the dusky dusk?

—The Cowardly Lion

So Bert Lahr, in the guise of the Cowardly Lion, begins his famous self-motivational speech from the Wizard of Oz—the laugh-out-loud portion of a movie that otherwise scares the daylights out of kids and provides enough bizarre imagery to make adults wonder what kind of potent substances the director might have been using.

Which is probably why that scene came to mind yesterday while reading the latest press release from Patrick Byrne, the CEO of internet-based, negative operating margin-achieving, also known as an Anti-Naked Short Jihadist whose public obsession with a back-office administrative problem turned into a full-blown conspiracy theory involving hedge funds, journalists, and the so-called Israeli mafia, among others.

Byrne’s movement culminated recently in a highly publicized Senate committee hearing targeting all manner of supposed naked shorting manipulation, not to mention dire warnings of purported unchecked hedge fund “power” and “abuse.”

About the only thing the Senators and their star witnesses didn’t blame on hedge funds, to borrow a line from Peter Falk’s character in “The In-Laws,” was atonal music.

But the SEC knows where its bread is buttered, so to speak, and this week its Chairman, Christopher Cox, announced new rules designed to further curb so-called naked short-selling. According to Cox:

"There are still persistent failures to deliver in the marketplace, and some of that is undoubtedly attributable to loopholes in our rules. Today, what we're moving to do is to close those loopholes."

Now I am all for eliminating those loopholes. But, as far as I can tell, it won’t change a thing about the way every hedge fund I know handles its short sales.

That's because, as I have written here before, every hedge fund I have ever known borrows stock before they short it.

The procedure is this: the hedge fund asks their prime broker whether a stock can be borrowed; if the broker locates a borrow somewhere on Wall Street, the hedge fund gives a trader the order to short the stock along with the name of the broker from whom stock has been borrowed. At the end of the day, when the hedge fund reports that short sale to their prime broker, the prime broker won’t book the trade if the stock hasn’t actually been borrowed.

No borrow, no short sale.

Thus, as anybody in this business knows and as the world’s most famous short-seller, Jim Chanos, will tell anyone who bothers to listen, there is no paper trail on Wall Street so clearly marked and so easily documented as the short-sale of a publicly traded U.S. stock.

Which means that the failures to deliver—gall and wormwood to the Anti-Naked-Short-Conspiracy-Theorists, who take them as a sign of hedge fund power, abuse, and market manipulation—must reside somewhere within the brokers themselves, not at the hedge funds who correctly borrow stocks before shorting them.

Nevertheless, the SEC’s belated efforts to tighten its rules generated headline news, including the press release in question, whose heading reads as follows: Applauds SEC's Courage in Addressing Naked Short Selling Issue

The body of the release contains the following words of wisdom and encouragement from Mr. Byrne:

"I congratulate the SEC for the courage they showed today, and I am grateful for the leadership of Chairman Cox. It is clear he understands the severity of the problem, and the Commissioners can be proud of the steps they are taking to end the blight of abusive naked short selling upon our capital markets."

Exactly what sort of “courage” was required for Mr. Cox to tighten up the rules is beyond me. I suspect it is an allusion to the dark forces Mr. Byrne has, in the past, accused of arraying against him and his company.

Those dark forces include—in addition to the aforementioned Israeli mafia—the supposed Russian and Italian mobs, as well as unidentified “miscreants” who are “trying to get the FCC (Federal Communications Commission) to launch an investigation” and “trying to get the DoJ (Department of Justice) to investigate me” as he told Bloomberg television last year.

I am not making this up. "Some of the officials are monsters," he also declared. "You'll probably read a headline that I was stopped with drugs or a dead body."

So I suppose Mr. Byrne thinks the SEC Chairman is taking his life into his hands by suggesting a few new regulations to tamp down naked short-selling, thus "courage."

Given that the body count of past SEC Chairmen who likewise proposed previous anti-naked short-selling rules is fairly low—zero, by my count—I rank Mr. Byrne’s motivational speech right up there with Bert Lahr in his lion costume:

Courage! What makes a king out of a slave? Courage! What makes the flag on the mast to wave? Courage! What makes the elephant charge his tusk in the misty mist, or the dusky dusk? What makes the muskrat guard his musk? Courage!

What makes the sphinx the seventh wonder? Courage! What makes the dawn come up like thunder? Courage! What makes the Hottentot so hot? What puts the "ape" in apricot? What have they got that I ain't got?

Whatever it is, it’s not courage.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


Anonymous said...

Jeff, inadvertently or not,you raise an interesting explanation, that the naked short sellers are Wall Street firms themselves. Trading desks working in concert with the market making operations. I don't know how closely any of this is scrutinized and by whom, but there is not any group with a bigger advantage than the trading desks of the major firms, who have access to all the order flow info, the upside down positions, the margin call info, etc. And any information and trading tools, legal or illegal, that Wall Street desks can use to their advantage if they don't think anyone's watching, they'll use if they think they'll make money.

Its_strange said...

OSTK's website tells us they are rebuilding the main warehouse in Salt Lake with the hopes of improving logistic efficiencies 100% and it should be done by the end of July. ....Well i wonder what that has done to this quarters results. Maybe something like thier software rebuild ?..

Good observation about Patricks comments

MS said...

Where do you think the fail-to-delivers came from?

cargocultinvestor said...

Wow Jeff. You seem to have a thing for Byrne & Overstock that dwarfs Byrne’s own obsession.

I have no firm belief as to whether hedge funds do engage in rampant naked shorting or not. I do believe however, that if they can get away with it, a majority of them will try. Remember the after hours trading of mutual funds? Remember the S&L’s being pillaged? Why can’t hedge funds be trusted? For the same reason that you dumped on the SEC in your preceding post. Greed. Its why people are attracted to Wall St & the market in the first place.

And what’s with Israeli mafia &“the supposed Russian & Italian mobs? There is nothing “supposed” about them. They exist & are involved in money laundering, pump & dumps, etc to the tune of billions of dollars. Whether they are involved in anyway with Overstock manipulation, I do not know. But neither do you Jeff. At least I hope not.
This I do know: organized crime makes $10’s of billions if not $100 billions each & every year and need to legitimatize these profits. The criminals are happy with 60-70% of the face value of their ill gotten gains returned as clean money. Do the math. The numbers are huge.The unregulated $ trillion hedge fund industry is a natural fit & IS a conduit for some of it. This money flows to where it's owners can remain hidden. I don’t mean to imply that all hedge funds are run by crooks. I’m sure there are some highly ethical people in the industry. Just not that many who will not bend the rules a little here & there, to make a profit in a highly competitive industry. Or bend them a lot. Or simply not ask questions about the source of the money. That unfortunately is human nature. Money is power & it corrupts without qualification.

The jist of all your Byrne/Overstock vs Hedge funds/Rocker/shorting postings seem to reiterate the theme “crazy ceo of imaginary business” blames his failings on “a bunch of honest upstanding guys” who are serving humanity by shorting stocks into the ground.

As far as naked shorting goes, I know very little. Byrne is taking your friends to court. Let the courts decide it Jeff, its their job.

Your obsession with Byrne is unsettling & makes a thinking person wonder. “methinks the lady doeth protest to much”

BHBigg said...

Funny how closed-mouth the hedge funds and their legion of apologists in the press and the rightwing of the GOP are about just how easy it is to sell short US shares without borrowing up in Toronto. Or how about how many US tech companies suddenly found their shares were being listed on the Bremen stock market during the post-September 11th meltdown. Now why do you suppose hedge funds were getting those shares listed on that inportant global market??

As the previous poster noted, greed, not some sense of social responsibility, is what motivates and drives most of us, especially those in the hedge fund world. If we can make money doing it, we'll do it. Sad but true.

Jeff Matthews said...

"CargoCult" is right. He knows very little about naked shorting.

But his comments are worth printing here, if for no other reason than they illustrate the incoherent, uninformed basis of the anti-naked-short-selling-jihad better than even a Senate committee hearing.

As for "ms" and the question of where the failures come from, I'd suggest following the trail to its source at the brokers themselves.

Shouldn't be hard.

gvtucker said...

There is one very big reason why a hedge fund wouldn't naked short sale that doesn't get mentioned--short rebates.

Ordinarily, a significant source of funds for a hedge fund, especially a short selling hedge fund, is that interest can be earned from the short sale proceeds. If there is a delivery fail, for whatever reason, then the hedge fund cannot get use of the proceeds from a short sale, and thus cannot earn interest from those proceeds. As Fed Funds rise above 5% and returns for the hedge funds dwindle, this interest becomes very important.

Chris Fischer said...


"This I do know: organized crime makes $10’s of billions if not $100 billions each & every year and need to legitimatize these profits. The criminals are happy with 60-70% of the face value of their ill gotten gains returned as clean money. Do the math. The numbers are huge.The unregulated $ trillion hedge fund industry is a natural fit & IS a conduit for some of it. This money flows to where it's owners can remain hidden."

Did I miss the 10-Q that "organized crime" put out? Since you "know" they make that much, can you point out a source?

Also, you seem to imply that hedge funds are laundering money for organized crime. I'm confused as to how you think this is happening. Are they dropping off suitcases filled with cash?

As far as Jeff's obsession (as well as Herb Greenbergs, Gary Weiss's, and well, mine) - really, I don't understand how people who understand basic economics and follow Wall St. aren't fascinated with Overstock and Patrick Byrne.

To me it is absolutely amazing that the crybaby, juvenile antics of a CEO who runs a tiny failure of a internet company can attract the attention of Congress and the SEC to the level he has.

But as myself, someone who has no financial stake in the outcome of all this, it really bothers me. Because the nation(Congress), and the stock market(SEC) have a LOT of very real problems to deal with, and really, this is attracting attention away from them.

You would hope that any first year business student could do a case study on Overstock and come to the conclusion that its share price is in the toilet not because of naked shorting, but because of the mounting loses, negative free cash flow, zero sales growth, with a board that provides almost NO governence whatsoever, run by a CEO who has little prior business experience who was funded by his family.

The fact that people are now blaming Enron on (naked?) short sellers scares the crap out of me for two reasons. 1) Are people in this country really that dumb and 2) What the scale of future corporate crime could be.

dkman said...

As a day-to-day practitioner of shorting, especially in this market, I have to agree with you Jeff.

As a trader I have very limited visibility into whether a stock is "shortable". After I place a short order for a stock with a broker I have to wait for them to say "you got it" or "we couldn't find any shares". In my experience, the ratio of yesses to nos is typically 70-30, although this greatly depends on what types of stocks are being shorted. If they say no, I just move on, so from this perspective I would say that it's difficult to say that hedge funds can systematically short stocks with no regard to their availability.

This is not to say that there could not be funds and traders out there who have "special" arrangements with their brokers, as was the case in the mutual fund late trading game.

I guess the ongoing investigation should be able to tell us if this is the case, but my educated guess would be that the vast majority of funds who practice shorting rely on their brokers for share availability before putting on trades.

Its_strange said...

Truth be said i also know very little about naked shorting . I'm a small retail guy who tries to pick the brains of pros ( love this internet ) but after NCANS decided to hide who is supporting it and after the press exposed Phil Saunders for who he is....... after Patrick opened his mouth i decided those are a few brains that ain't worth picking ....And that ain't a very sharp or astute observation to make....Even for Senate Judiciary