Thursday, October 01, 2009

Jim Chanos for SEC Chairman!

The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.
—The Securities and Exchange Commission

That’s not just us here at NotMakingThisUp talking, that’s what the SEC itself says right on its very own website.

And as part of that mission, the agency just wrapped up a two-day forum on “short-selling and securities lending.”

Never mind that short-sellers had nothing to do with—absolutely nothing—the sub-prime lending crisis or the Bernie Madoff fraud.

And forget entirely that it was a short-seller—not a public bureaucrat or a college professor—who first warned, well ahead of its collapse, of the dangers lurking in the Lehman Brothers balance sheet.

Public respect-wise, short-selling simply seems to be a no-win business model.

In bull markets, naturally, nobody wants to hear the bad news that is the short-sellers’ stock in trade. After all, what parent wants to be told they have an ugly baby…and what investor, or CEO, or working stiff, wants to be told they own, or run, or work for an over-rated company?

In bear markets, on the other hand, investors, CEOs and working stiffs alike look for scapegoats on which to blame their problems…and who better to blame than the short-sellers who profit from such calamity?

Indeed, having practiced short-selling as a hedging tool over nearly 30 years of investing, we were not a bit surprised by the efforts of some politicians and at least a few corporate CEOs to blame the entire financial crisis on the short-sellers who actually saw the thing coming, warned about what could happen, and made money as a result.

In those 30 years, every corporate big-wig we’ve ever observed who sat at the helm of a controversial, and sometimes fraudulent, business—convicted felons Jeff Skilling, Richard Scrushy and Dennis Kozlowsky among them—have at one time or another fingered “the shorts” for their problems. They do it the way bloated, fading home-run hitters blame positive steroid tests on errant trainers and bad doctors...anything but their own malfeasance.

Now, one method for more effectively regulating markets was proferred in a recent New York Times piece by the formidable Gretchen Morgenson, “But Who Is Watching Regulators?”

Instead of creating more regulations to try to prevent this kind of mess from recurring, why not figure out how to hold regulators accountable when they perform as poorly as they did in recent years?

Edward J. Kane, a professor of finance at Boston College and an authority on the ethical and operational aspects of regulatory failure, has some ideas about how to do this and right our damaged system in the process. He outlined them in a recent paper titled “Unmet Duties in Managing Financial Safety Nets.”...

Now, we here at NotMakingThisUp have enormous respect for Morgenson: she’s a tough, no-holds-barred financial reporter who takes nothing at face value.

But Kane’s ideas seem to have a little less oomph than what the financial markets need. First among these ideas, for example, is an “oath of office”:

Mr. Kane suggests that financial supervisors take an oath of office in which they agree to perform four duties. First is the duty of vision, under which they would promise to adapt their surveillance practices to respond to the creative ways financial institutions hide their dubious practices.

Regulators must also promise to take prompt corrective action, and to perform their work efficiently. Finally, there is what Mr. Kane calls the duty of “conscientious representation,” whereby regulators swear to put the interests of the community ahead of their own.

—But Who Is Watching Regulators? by Gretchen Morgenson, The New York Times, September 12, 2009

All of which seems, to real-world practitioners in this business, crushingly naïve.

After all, every elected representative in Congress swears an oath of office to defend the Constitution of the United States—yet the head of the House Ways and Means tax-writing committee of this country is, by public accounts, a tax cheat. And the current Treasury Secretary of the United States—likewise an oath-taker upon assuming office—was, until nominated for the post and forced to pay up, likewise not exactly obeying the letter of the laws he was swearing to defend.

Now, this isn’t about Republicans versus Democrats—Republicans have plenty of their own on the honor role of oath-taking scoundrels. It’s simply about how to regulate markets in order to “protect investors.”

And it seems to us that the best way to protect investors is not to require particularly severe oath-taking on the part of regulators: instead, it is to appoint to the head of the SEC somebody who knows where to look to find the problems before they can hurt the investors the SEC is charged to protect.

Thus it is that—no offense to Mary Schapiro, who has provided an admirable spark of life into what had been rendered comatose by the previous regime—we here at NotMakingThisUp nominate Jim Chanos as next head of the SEC.

A professional short-seller, Chanos first made his bones nearly 30 years ago sniffing out fraud at Baldwin-United when that highflyer was beloved by Wall Street’s Finest. Jim did this by doing what Wall Street’s Finest did not: digging through mundane state insurance filings and piecing together a far less pretty picture of the business than Baldwin’s charismatic CEO was painting to Wall Street’s Finest and the investors who ultimately lost their shirts on the stock.

More recently, Chanos was the first to publically call out the accounting scam underlying Enron’s so-called “earnings” (“a hedge fund in drag,” I believe he called it), and he performed the same service in the case of Tyco, for which he received nothing but grief from Wall Street’s Finest—until that story likewise fell apart.

So, who better than Jim Chanos to spot—early, when it matters—the next Madoff, or Scrushy, or Skilling, or Kozlowsky?

It certainly isn’t going to be a finance professor from BC, or even a securities lawyer from GW, no matter how many oaths they take.

Of course, our proposal is, in itself, as crushingly naïve as that of Mr. Kane’s.

The very fact that the SEC just devoted a day and a half to the issue of short-sellers—the one investor class that publicly warned against the lending practices that nearly brought down the entire financial system—tells you everything you need to know about where short-sellers stand in the eyes of regulators.

And Jim Chanos himself will probably choke on his coffee, if and when he reads this. (Full disclosure: Jim is a professional acquaintance, and our paths cross once a year or so—usually in the breakout session of some extremely controversial company, where his presence tends to cause the CEO’s eyes to twitch.)

Still, in our opinion, competence—not oaths—is what makes a great anything, whether it’s a member of Congress or a general or a CEO or a school teacher.

And in the world of “protecting investors,” we can’t think of anyone more competent to spot a problem than one of the best short-sellers who ever practiced the craft.

Now, for the record, we here at NotMakingThisUp have no problem with ideas on the table for tightening up the stock-lending process that has resulted in near hysteria about “naked shorting” among Congresspeople who wouldn’t know a short sale from a tomato.

And we lived with the “up-tick” rule for 25 years or so before the wizards of the Bush Administration decided to revoke that rule at the absolute top of the market—so restoring the up-tick rule would seem to us to be no skin off anybody’s nose.

But the way you “protect investors” is not to shackle short-sellers. These are, after all, professionals who’ve made it part of their business model to sniff out the kind of fraud the SEC wishes to abolish from the system.

It’s hard to imagine that if Bernie Madoff had been running a public company, his scam would have gone on for two and a half years—let alone 25 years—with shorts on the prowl.

Or a Jim Chanos at the helm of the SEC.

Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only 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 investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author


marketmania said...

#1 greatest idea of the month!!! He is a billionaire, right? Maybe he...nahhhh

But What do I Know? said...

This all goes back to the unspoken assumption that high asset prices are better than low asset prices. This is ridiculous, of course, since high prices in stocks and bonds are (like anything else) good for the seller but bad for the buyer, but the mantra of High Prices Good, Low Prices Bad which is bleated out by Wall Street and its media flock. The working savers in this country ought to love lower prices--since they are purchasers of stocks and bonds--but instead they are fed the notion that the Fed and the government must do everything it can to keep asset prices up with low interest rates and tax credits.

If I had a company, I would keep some cash around waiting for the short-sellers to knock prices down (but I suppose they don't knock prices down on companies that do :>))

I nominate King Canute for SEC chair!!!

CurmudgeonlyTroll said...

If there were any fairness in the world, people who got everything right for the last five years would be looked to for lessons to learn, and people who got everything wrong would get their comeuppance.

But nooooo....In the immortal words of Steve Martin, the media and regulators listen to the CEOs who got everything wrong, and everyone wants to hound and harass hedge funds and short sellers.

Something wrong with this country when idiocy is this entrenched...but at least we're predictable - Bill Maher was the only one who lost his job over 9/11.

Anonymous said...

From my limited contacts with JIm Chanos over numerous years I would postualte that Jim Chanos is a highly ethical guy. I knew him from his days in Chicago with Gilford Securities (as a matter of fact I think I still have his business card from back then). At that time Jim was digging into Baldwin United and telling its owners of impending problems. At the same time, he also recommended buying Seiko for its efforts in (and I am not making this up) personal computers, for a sell side analyst only has a limited audience with short ideas. After some time, Jim startlingly but humbly admitted his mistake with Seiko (something that numerous of Wall Street's Finest only do under extreme duress) and pointed out that as a human he too could err. As a buy sider for too many years to recount, I'd occasionally see Jim in one of those breakout sessions that you referenced. Usually, as far as I could tell, he preferred to blend into the woodwork just like I did. I always found him amiable and pleasant. Perhaps the notoriety that came from his Enron and Tyco work changed his anonymity among the crowd.

Anonymous said...

Your argument is fun and amusing but I am compelled to point out several flaws. First the Uptick Rule was in place since 1938, (not 25 yrs ago)and does nothing to shackle short sellers. It prevents manipulation via bear raids that occurred in the 1930's and then they reappeared in 2008. The SEC is to protect the investors. Shorting is not investing, it distorts price discovery by adding new supply of shares to sell thus creating an artificial bias to the downside, and then when buying to cover, the shorts reduce supply thus creates bias to upside. Result is more volatility and a casino for a stock market. Long term investors and thousands of quality companies have been harmed by the manipulative shorts..along with the help of; naked shorts, and mark to market accounting changes (the real reason Lehman and Bear failed not the BS of bloated balance sheets) and then don't forget the 50 trillion in credit default swaps that the regulators failed to regulate that leveraged the shorts sellers hand. Your perpective champions the shorts when in reality they were the reason the financial blunders then became a crisis at all.
The SEC just completed a round table seeking advice from the wolves on how to guard the hen house......yet the public forum of letters written were well over 95% in favor of an uptick rule reinstatment. The SEC has always been in the pocket of wall street and the governers all get cush Wall Street jobs after serving their terms....Cox is now getting paid millions at his new is sick. You have 5 governors getting paid less than 90k per year policing hedgefunds and firms making Billions! A simple recipe for potential corruption and no wonder they rule consistently in their favor. It has killed the goose.
JK Alexander

Jeff Matthews said...

Re: Anonymous... I didn't mean to suggest Jim made his presence known in meeting with management: his mere presence in the crowd is enough to make CEOs nervous.

Re: JK Alexander... I never said the uptick rule was only around for the last 25 years: I said I'd lived with it while shorting stocks for 25 years. Next time, read what is written.

As for the rant, well, you have it so backwards it makes the head spin. No short-seller loaned money to people who couldn't afford a house in the first place; and no short-seller forced Lehman to buy bad real estate; and no short-seller forced the private equity boys to pay stupid prices for stupid properties.

As for naked shorting, you have not a clue what you are talking about.

You clearly have never shorted a stock yourself, otherwise you'd know why Fannie Mae went from $25 to $1 a share AFTER the Feds banned short-selling altogether during the crisis. Naked shorting isn't practised in any way by any serious investor.


Sanjiv Bhamre said...

This is making self-interest work for the public interest.

Because it is in the interest of short-sellers to find what could go wrong in their stocks, they sniff out the bad odor much before others. And because of lot of practice in doing so, they must be really good at it.

The idea really makes logical sense.

Sanjiv Bhamre

Anonymous said...

Jim Chanos is too valuable to waste at the SEC. He should be Chairman of the Federal Reserve (especially if Jim Grant doesn't want the job).

Unknown said...

Good idea - but, unfortunately, Chanos is too smart (and rich) to take that job.
Instead, how 'bout Judge Jed Rakoff, who is currently overseeing the BofA/Merrill Lynch litigation with the SEC? At least he seems to understand that the SEC is supposed to be protecting shareholders, not company executives (something the SEC has forgotten).