A long article on shorting sent to me by a friend- you are ALL patriots no matter what you do financially (imo), I care about you all, very much, I am proud to think of all of you as my friends, and I am not able to understand the market, at all, and I did not even try to read the article- I know my limitations. Karen, I apologize that is is so Looooooooooooooooooong:
The Short Selling Trilogy
By MARTIN HUTCHINSON, UPI Business and Economics Editor
As a service to readers, we publish here Martin Hutchinson's three recent
pieces on short selling: a "Bear's Lair" column in which he discusses the
value of short selling, a review of a new book "Sold Short" about short
selling in the bull market of the late 90's and an interview with the book's
author, Manuel Asensio.
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The Bear's Lair: Shorts -- the true patriots
WASHINGTON, July 2 (UPI) -- With the Fourth of July this week, it's about
time this column celebrated the true unsung patriots of the free market --
short sellers, who speculate against stocks they believe to be overvalued.
Without them, fraud and manipulation would go unpunished and the free market
would be a corrupt sham.
Short sellers have a bad historical reputation, and intuitively one can
see why. If Merrill Lynch is bullish on America, then short sellers are, by
definition bearish on America and are thus in some sense subversive.
In the aftermath of the 1929 crash, it was thought by the U.S. Congress
and other unsophisticated thinkers that the crash itself had been caused by
short selling. Thus the Securities Act of 1933 included a number of
protections against short sellers, including the intellectually bizarre
"uptick rule" by which it was illegal to sell a stock short except
immediately after an upward move. Naturally, this rule, which is still in
effect, hindered legitimate short selling while not inhibiting manipulators
in the least -- they just manipulated the system by pushing through a small
buying order before a much larger selling one.
Much of the intellectual detritus of the 1930's -- Bauhaus architecture,
admiration of Stalin, a belief that government was more efficient than the
free market -- has, thank goodness, been consigned to the dustbin of
history, but suspicion of short selling is still with us, and hence the
activity needs to be examined more closely.
Short selling differs from ordinary stock purchasing in that it is much
riskier, for two reasons. First, the theoretical loss on a short position is
infinite -- while a drop of 50 percent is huge, a rise by 200 or 300 percent
in a volatile stock is quite possible, and so a short seller can certainly
lose far more money than a buyer for the same net exposure.
As the great 19th century speculator Daniel Drew is reputed to have said:
"He who sells what isn't his'n, Must buy it back or go to prison."
Second, in order to carry a short position, it is necessary to "borrow"
stock from another broker, so that stock can be delivered when the short
sale takes place; this borrowing is generally considerably more costly than
an ordinary bank loan because of the limited supply of stock and limited
number of stock "lenders," hence making short selling very expensive indeed
if the position has to be held for a substantial time.
With the exception of the inevitable flotsam of amateur speculators that
get washed out by the first unexpected bull run, short sellers are thus
generally knowledgeable and are speculators rather than investors, because
of the cost to them of holding for a long period.
In general, short selling is not a particularly profitable business -- one
thinks of the famous 1920's and 1930's "bear" Jesse Livermore, who ended up
destitute in 1940 after a decade that, based on the market's overall
behavior, should have been uniquely lucrative for him.
Livermore's failure illustrates well both the theoretical basis and the
shortfall of short selling. In general, short sellers are "value" investors;
in other words, in the same way as Warren Buffett but in the opposite
direction, they seek to discover hidden values in the stocks they trade --
in the case of short sellers, hidden overvaluation.
The huge disadvantage of this approach for short sellers is that, as
Livermore discovered, values need not correct themselves immediately. In
Livermore's case, he lost money waiting for stocks to drop in the latter
stages of the 1920's boom, and then lost money again by buying on margin in
1931-32, when he felt that the market fall had gone too far -- instead of
rebounding, the market dropped still further.
There is however, a corresponding advantage to short selling that is not
available to a value investor on the "long" side. A value investor buying
stocks is seeking stocks that the market has undervalued, that have
earnings, assets or prospects greater than the market has perceived. In
this, the value investor is on the same side as company management.
Consequently, the published information about the company being invested in
generally reflects the values being sought, and the value investor's job is
simply one of better analysis than his competitors in the market.
On the short side, the position is different. In general, there are two
potentially profitable situations for the short seller; the situation where
the underlying company is of value, but the stock market has indulged in an
orgy of speculative overvaluation, and the situation where the company
itself is worthless or fraudulent. The latter case, if it can be detected,
is potentially much more profitable and less risky than the former.
In the former case, the short seller is not researching something unknown,
he is researching something that is very well known by other investors, and
may indeed be extremely popular. Hence he is always running the danger
summarized by the title of Charles Mackay's 1851 classic "Extraordinary
Popular Delusions and the Madness of Crowds." If the delusions remain
popular, and the crowds remain mad, the stock may go on climbing, and the
short seller may lose his shirt. Many such sad stories were told in the
great 1996-2000 bubble, and have been told in every bubble since the great
South Sea inflation of 1720.
In the case of fraud, or, even without outright fraud where the underlying
company is worthless, the short seller's position is much stronger. Here,
the short seller, through diligent research, has discovered something that
nobody else knows about and that company management is trying diligently to
hide: that a company that is well thought of in the market, in fact has poor
prospects, a product which does not work, or financial statements that
misstate profits through accounting chicanery.
This is the short seller's value to society, which has been surprisingly
little recognized. He keeps the market honest. Without him, it would be in
everybody's interest for news of defective products, mis-stated earnings and
outright fraud to be swept under the rug while the retail investor, either
directly or through badly run mutual funds, buys overpriced securities that
insiders want to get rid of.
The short seller's interest is to counteract this, to publicize the
defects, misstatements and frauds as widely as possible (once he has
acquired his short position) in order that others may sell and the stock
drop.
Short sellers do not flourish in the big investment banks where the
possibility of offending providers of issue business is too great. Instead,
they typically operate through small brokers and "hedge funds," often
undercapitalized, that exist at the margins of the financial community. A
recent book "Sold Short" by professional short seller Manuel Asensio (which
UPI will shortly review), outlines their techniques by means of "war
stories" and demonstrates that the life of a short seller is exciting -- and
intellectually stimulating if you like running counter to the big battalions
(including the New York Stock Exchange itself, whose fees are paid by
listing companies, not short sellers.) It is however, by Wall Street
standards, not especially lucrative.
Nevertheless, the short-seller's activity is a vital market discipline,
and one which has been seen too little in the tech bubble of the last few
years. Through it, capital is drawn away from the overpriced and the
fraudulent, and reallocated to sounder investments where the short sellers
are not active. This is wholly beneficial for the economy; there can be no
health in an economy where the meretricious are as capable of attracting
capital as the sound.
As I said, short sellers are the true patriots. They engage in an activity
that is very dangerous and not particularly lucrative and cleanse the market
of hype, error and fraud.
This July 4, let us in the annual parade salute short sellers, and not the
stock market bubble blowers of Merrill Lynch and their ilk.
(The Bear's Lair is a weekly column which is intended to appear each
Monday, an appropriately gloomy day of the week. Its rationale is that, in
the last 10 years, the proportion of "sell" recommendations put out by Wall
Street houses has declined from 9 percent of all research reports to 1
percent. Accordingly, investors have an excess of positive information and
very little negative information. The column thus takes the ursine view of
life and the market, in the hope that it may be usefully different from what
investors see elsewhere.)
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Book Review: Sold Short
WASHINGTON, July 10 (UPI) -- "Y'know, there's only so many investment
bankers in the world" sneered a Morgan Stanley recruiter to then-interviewee
Manuel Asensio in the mid-1970's.
Luckily, Asensio has since been able to make a very successful career out
of thwarting the glut of dubious investment bankers that infested 1990's
Wall Street. "Sold Short -- Uncovering deception in the markets" by Manuel
P. Asensio with Jack Barth (Wiley, $29.95) is an account of his life's work.
It is in parts heavy going, but well worth it.
Short sellers such as Asensio typically research companies to find
examples of situations where a company's stock has been bid far above its
intrinsic value. Such situations may include good companies that have
entered the stratosphere through speculative hype, but more typically
include stock promotions involving deception of the investing public.
During the late 1990's, both types of situation existed in abundance, but
one suspects that one of the reasons for Asensio's survival is that he
concentrated on the latter, rather than attempting to "fight the ticker" by
shorting say Cisco or JDS Uniphase, two legitimate companies whose stock
prices got way ahead of themselves.
Asensio tells his tale by means of "war stories," accounts of his notable
successes, and in one case, failure. Typically, he undertakes detailed
research on a situation (very often from publicly available Security and
Exchange Commission filings), accumulates a short position, then publicizes
the negative information he has obtained, both directly to the public and to
major outside shareholders in the company, hoping thereby to cause a major
downward re-evaluation of the company's stock.
Naturally this infuriates company management, particularly in cases where
Asensio has determined that the company's main product lines do not work, or
that its managers have a long history of investment fraud. This is where the
business gets rough, and is not for the squeamish; Asensio needs both
excellent (and generally expensive) lawyers and presumably a certain amount
of personal security as well. In addition, such is the nature of Wall Street
that Asensio's deals wait for no man; in one case the crucial episodes of
the saga took place while he was immobile in hospital.
"Sold Short" is interesting on two levels. On one level, it demonstrates
how short sellers work, and why their profession is essential to the proper
functioning of a securities market. As I have written previously, the gamy
reputation of short sellers, dating from misguided 1930's perceptions of
them being responsible for the 1929 Crash and the Great Depression, is
entirely unmerited, although there is no question that their activities are
difficult, risky, and not always very lucrative.
There are a number of relics of 1930's securities legislation, notably the
"uptick rule" (by which you can sell short only after an uptick in the stock
price) and the need to "borrow stock" from a holder to sell it short, that
bias the market against short sellers and make short positions difficult to
hold for a prolonged period. Asensio briefly discusses these, and makes a
plea for their abolition, some, but not quite all of which I agree with. (I
don't see how you can allow short selling in a stock on an entirely
unlimited basis, otherwise you will create the possibility of short sales in
a stock to the extent of many times the issued share capital, a recipe for
market collapse.)
On the other level, Sold Short" can be read simply as a saga of human
fallibility and greed. It tells, for example of the Morgan Grenfell
merchant banker who caused Morgan to lose $500 million or so, then escaped
prosecution by appearing in court in a dress and claiming to be mad. It
tells of the chicanery surrounding the New Jersey Turnpike E-Z Pass
concession, alarming enough to make one wish President Bush had read it
before naming ex-Governor Whitman to his Cabinet. It tells of the Venezuelan
gold promotion which, unlike most such promotions, represented an entirely
genuine mine but a wholly false claim to it.
And, it tells also, of an Internet stock that was grossly over-hyped, sold
short by Asensio, and then went on to further heights through being bailed
out in very questionable circumstances by President Clinton's Commerce
secretary.
But in the end, one returns to the beginning. Short selling is a rough
business, and Asensio, who is very good at it, was clearly not the "type"
for investment banking. However, markets have two sides, and opposing
Asensio are the investment bankers themselves, promoting the over-hyped and
very often fraudulent merchandise that Asensio is short-selling.
In other words, the 1970's Morgan Stanley recruiter was right; there is
room for only a certain number of legitimate investment bankers. By opening
the floodgates, in terms of numbers, background, and remuneration, Wall
Street created not extra value but extra hype and fraud.
If you have any financial interest in the stock market at all, "Sold
Short" will make your blood run cold. Read it.
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Interview: Manuel Asensio, short seller
WASHINGTON, July 13 (UPI) -- As I discussed last week, short selling is a
much neglected topic, but is essential to the functioning of a free stock
market.
Manuel Asensio, author of the recent book "Sold Short" (Wiley, $29.95) is
one of the leading short selling practitioners on Wall Street. Cuban born,
brought up in Brooklyn, Asensio graduated from Wharton and Harvard Business
School. His company, Asensio and Company, specializes in intensive research
into companies and situations that Asensio considers overvalued. This
business is only moderately lucrative because of the high costs; it involves
frequent regulatory and legal battles with the Security and Exchange
Commission, the New York and American Stock Exchanges, and the companies in
which Asensio takes a position -- he claims to have appeared in front of 19
judges in the last five years.
A natural "fighter against City Hall" Asensio is straight talking, with a
strong personality, as I discovered in our conversation:
Q: (Hutchinson) Why write a book? Surely anything else you could be doing
is more financially rewarding?
A: (Asensio) The book can never pay back the costs that I've incurred to
hire publicists, or the legal costs, because I had to agree to pay legal
costs of a First Amendment lawyer for the publisher, and one for myself, so
I ended up paying one First Amendment guy to put as much material as
possible into the book, and another First Amendment guy to keep as much as
possible out of it. So it's certainly not a for-profit venture.
Q: I didn't think it was.
A: I invented hostile adversarial short selling. And I'm the only
practitioner, I'm the only one dumb enough to do it. I needed a vehicle by
which I could tell my story and put it up for criticism. My work, ever since
October 1998, has been so influenced by litigation, which has a cost,
because stocks no longer react in price to my reports as they used to.
Winstar (a cellular telephone company which filed Chapter 11 in April 2001)
reacted, but we caught Winstar and its analysts with their pants down. The
company was within two months of being bankrupt and they were saying
everything was great and the balance sheet was fabulous; it was one of the
biggest accounting frauds on Wall Street and still hasn't been exposed as
that. There were a couple of frauds there, an operating fraud, since the
radios didn't work as they said they did, and also an accounting fraud
because they were capitalizing such a vast amount of expenditures and also
they were creating revenues through transactions with related parties.
So in 1998 when we were confronted with the litigation (seven lawsuits) I
made a decision to defend myself and the company, and not to file
bankruptcy. The only way to consolidate the lawsuits in New York was to file
bankruptcy, which would have taken me out of business. So one prong of the
defense strategy was to write the book.
Q: Why did you get into short selling and would you do it again if you
were starting again? Is there a psychological attraction, or did you just
see a niche?
A: For someone to do what I did, there has to be a psychological basis.
People don't do what I do, people don't go against the status quo openly,
people don't lead with their chin, people don't expose themselves to this
kind of public treatment and harassment. It's not what people like to do.
And at some level I am not afraid of it, I welcome it, and perhaps enjoy it.
And that's a problem personally, but for society overall, to have a guy draw
the line with a Carter (chief executive officer of Hemispherix, one of
Asensio's "shorts," that hasn't entirely worked out), let him make some
money. (In the Hemispherix case) the money's been taken away from me,
though; the incentive's been taken away.
Q: From the book, you've gone in for shorts where there were clear legal
problems in general. Obviously in the last year there's been a lot of money
to be made on the short side in Cisco, JDS Uniphase, Nortel, companies
people believed in, that probably had some underlying benefit to them and
yet got way ahead of themselves. Do you draw a distinction between the two
cases?
A: When we were in a raging bull market, it was hard to short "irrational
exuberance," because of the trend investing, the momentum investing, the
amount of money that Americans were taking out of savings and putting into
equity mutual funds, and in turn into these overvalued stocks. So we had to
concentrate on fraud, where once we'd sold them there was no coming back,
where we knew that eventually no-one needed to own that stock and it would
go to zero.
Now (in the larger companies) we find the same type of behavior, even a
denial of the deterioration in the underlying fundamentals. So the
literature by the analysts, that directly leads to the commentary by the
media, is directly opposed to what the actual position is, making that now a
more likely market. Take Verisign, valued at $10 billion, with 24 analysts
defending it. Philosophically I'm opposed to Verisign because they got their
wealth by paying politicians political bribes, and it's un-American to make
money by paying politicians to keep competition out. The numbers are
outrageous there, the multiples of future earnings that these analysts are
predicting are excessive.
Q: So, if we are indeed in a bear market now, with the overall trend maybe
downwards or at least not sharply upwards for the next 3-4 years, does that
help make you rich, or not?
A: It depends on how we handle the litigation, and what the results of the
litigation are. If we come out of the litigation quickly and are back in
business, we think we can be very profitable. We still have the "fraud"
companies trading at big multiples -- Research Frontiers, ParkerVision,
companies that are complete stock promotes, and eventually they're going to
have a crash. In the bull markets, those stocks, that were worthless, the
real ugly ones, got to $700 million, $800 million, $1 billion. That's where
we made our money. It's unlikely in a bear market that a group of promoters
could successfully get a zero stock up into the $500 million plus range. So
with the amount of capital we have to invest, we're going to have to do a
larger number of smaller deals.
Q: But you'll still concentrate on the ones that are fraudulent? There are
lots of $50 billion companies out there that should be $5 billion companies,
and they would seem good shorts.
A: We will participate in those markets if the literature being produced
by the analysts is so diametrically opposed to what the factual evidence
prescribes, that they become part of our market because they're fraudulent.
But I'm not good at the macroeconomic stuff -- I prefer to go round
drugstores, for example, to find out what they're selling a blood testing
piece of paper for, to find out if a company's committing Medicare fraud.
Q: You're in fact forensic analysts, not just surface analysts who look at
accounting games.
A: Yes, we're very grassroots, as low as you can get. Wall Street has
biotech analysts; I don't know what a biotech analyst is. I want someone
who, for example in our Vasomax case, knows about the nerve that controls
the artery that controls the flow of blood to the male organ.
If I want to know about radios, for Winstar, I don't want to talk to the
guy that makes the radios, I want to talk to the guy that knows the science
behind the components that go into the chip that goes into the radio -- the
lowest level possible. That's where the truth is. If you know that at 28
gigahertz, the signal can't go through rain, that's the fundamental driver;
you can't have a telephone system like that. The analysts on Wall Street
don't get there -- "we go around those little water drops" -- the funniest
conversation I ever had was with an analyst whose fund owned 12 million
shares, the day before I published on Winstar. He told me "You're wrong, go
ahead and publish" -- 45 days later, the company was bankrupt and they'd
never sold a share.
Q: That's the appeal, isn't it!
Q: Do you think the level of promotion of nonexistent companies or things
that don't work goes up in a bull market, or is it fairly steady?
A: As I said, the values will be smaller, but there will always be
promoters. However, the big thinkers in our society say that this bubble is
no different from any other bubble in our history, that happens every so
often. I disagree, I think that corruption at Goldman Sachs or Morgan
Stanley has become almost as bad as we used to have at First Jersey (a
notorious stock promoting brokerage of the 1980's that was forced out of
business by regulators) and the like. There is no "we won't do that, for
integrity, even though it's going to pay a buck."
The SEC, which is an arm of the securities business, has cracked down on
low level fraud and the Goldman Sachs of the world have soaked up those
funds through mutual funds. The same small investor is getting hosed by the
big boys now in a classier act. First Jersey's been put out of business, but
the big boys took over. And guess what, they know how to do it a lot better,
and it's far more damaging to society.
It's less damaging to society to have a teenager whose father was a
garbage man getting on the phone because he's making more money in a month
than his father made in a year, to have a few of those calling on farmers
and dentists, than it is to have a systematic effort to promote growth
stocks as the best performing asset class, so that society saves less in
fixed income and other, sounder securities.
--
Copyright 2001 by United Press International.
All rights reserved.
--
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