Doug Kass has a piece in the FT today that is a must-read in the current environment.
Coming on the heals of my post last night, I think what Mr. Kass has to say, as an actual short seller is gospel on the subject.
Kass writes:
Short-selling runs deep in financial history. Perhaps the first case dates to 1609 when the Dutch trader, Isaac Le Maire, targeted the shares of the shipping company Vereenigde Oostindische Compagnie (the Dutch East India Company). VOC was the first multinational corporation in history and had broad powers. Nonetheless, Le Maire, concerned about threats of attack by English ships, sold VOC’s shares short. After learning about Le Maire’s tactics, the stock exchange governing VOC’s trading banned short-selling (although the ban was later revoked).
In the early 1630s, the Dutch economy fell into a depression following a speculative peak in the trading of tulips. Again, short-selling raised the ire of regulators, many of whom saw it as magnifying the effect on the Dutch economic downturn. As a result, England banned short-selling outright.
Almost 420 years later – in the late 1920s – short-sellers warned of the consequences of speculation. But in the aftermath of the Wall Street crash of 1929, many blamed them and the uptick rule – which banned short-selling on downticks – was instituted (and stayed in effect until 2007). More regulation governing short-selling came into force in 1940, with a ban on mutual funds from short-selling (though that law was lifted in 1997). In early 2005, the SEC again sought to restrict the practice.
Yet short-sellers have served as financial watchdogs, as many of their warnings have been spot on. The delusional dotcom boom in the late 1990s brought Cassandra-like utterings from the short-selling cabal that proved insightful but were largely ignored. After the subsequent 75 per cent collapse of the Nasdaq, a bull market in corporate fraud emerged and short-sellers such as David Rocker, founder of Rocker Partners, highlighted accounting problems at companies such as Sunbeam, Tyco and Lernout & Hauspie. Kynikos’ Jim Chanos played a role in uncovering the largest fraud in history when his contrary-minded analysis warned of Enron’s accounting shenanigans – which were emulated (but ignored by investors) in the banks’ recent dalliance with structured investment vehicles.
By the middle of the decade the property cycle was in full bloom and David Tice of the Prudent Bear Fund warned of the dire ramifications of a downward spiral in home prices on the levered balanced sheets of Fannie Mae (FNM) and Freddie Mac (FRE). Soon thereafter, Nouriel Roubini, the economist, voiced particularly pessimistic forecasts about the housing market’s impact on credit.
Drawing a line between economic and market progress as against fantasy is a role taken by the few. Short-sellers provide an anchor of objectivity in an investment world populated by those more interested in rewards than in uncovering systemic risks. This week, Mr Cox said the SEC would announce new regulations to restrict short-selling. Instead of more regulation, the chairman and investors should begin listening to what short-sellers have to say about our economy and credit markets.
Kass points out the truth, until the things short sellers warn us of stop coming true, the SEC would be well advised to focus its energies elsewhere.
Disclosure (“none” means no position):None
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