Oh, this is going to get the Sith Lords all hot & bothered!

Both the WSJ and Bloomberg have articles this morning about Naked Shorting. The Bloomberg article more explicitly suggests that Lehman was “brought down,” in part, by naked shorting:

Naked Short Sales Hint Fraud in Bringing Down Lehman

“The biggest bankruptcy in history might have been avoided if Wall Street had been prevented from practicing one of its darkest arts.

As Lehman Brothers Holdings Inc. struggled to survive last year, as many as 32.8 million shares in the company were sold and not delivered to buyers on time as of Sept. 11, according to data compiled by the Securities and Exchange Commission and Bloomberg. That was a more than 57-fold increase over the prior year’s peak of 567,518 failed trades on July 30. The SEC has linked such so-called fails-to-deliver to naked short selling, a strategy that can be used to manipulate markets. A fail-to-deliver is a trade that doesn’t settle within three days.”

This is one of those things that is easy to allege, hard to disprove, has coincidental supporting data, and provides just enough plausability to make people forget (albeit temporarily) the cold hard facts of the day.

If I were at Bloomberg, here is how I would have written this article:

Over-Leverage, Under-Capitalization Brings Down Lehman (Update)

“The biggest bankruptcy in history might have been avoided if Wall Street had been sufficiently capitalized, used only moderate leverage, and avoided making false assumptions in their econometric models.

As Lehman Brothers Holdings struggled to survive last year, it was using as much as 40 to 1 leverage to purchase AAA securities that turned out to be no where near as safe as the triple A ratings assigned to it by Moody’s and S&P made them appear. Lehman, the second largest securitizer and trader of mortgage backed securities behind the also defunct Bear Stearns.

Wall Street continued practicing one of its darkest arts — the over rating of securities, bonds and derivatives — by self-interested parties in exchange for fees. In the 1999-2000 tech boom, the analyst community vastly over rated stocks with “Buy” and “Strong Buy” ratings. Sell wa hardly in their vocabulary. These were mostly profitless “dot com” companies built on the merest of concepts. The underwriting fees were substantial, however, and the analysts firms were well paid via large syndicate and IPO banking fees.

The same conflict of interests remained on the Wall Street, even after the dot com collapse. This time around, it was the ratings agencies — Moody’s, S&P, and Fitch — that slapped triple A grades on paper that turned out to be junk in exchange for huge fees from the underwriters.

The SEC has yet to seriously investigate how and why so many triple A rated issuances have collapsed and failed. These highly rated papers are linked to “payola” ratings, a practice that involved Ratings Agencies selling their highest seal of approval in exchange for large fees.”

When we were short Lehman at the time, from $30 and higher — it was an easy borrow, and there was no need for anyone to short naked. That was not why they went bankrupt.

My biggest regret about Lehman Brothers — aside from all the unfortunate souls who lost their jobs when the company imploded — was that I lacked the cojones to buy a big slug of Puts when we went short . . . They seemed kinda pricey at the time.

>

Previously:
Financial Sector: Beware LEH, CIT (June 3rd, 2008)

http://www.ritholtz.com/blog/2008/06/financial-sector-beware-leh-cit/

Gasparino vs Einhorn, Kohn & Ritholtz (June 5th, 2008)

http://www.ritholtz.com/blog/2008/06/gasparino-vs-einhorn-kohn-ritholtz/

Source:
Naked Short Sales Hint Fraud in Bringing Down Lehman
Gary Matsumoto
Bloomberg,
March 19 2009

http://www.bloomberg.com/apps/news?pid=20601109&sid=aB1jlqmFOTCA&

Naked Short Sales Provoke Complaints but No Cases
KARA SCANNELL
WSJ, March 19 2009

http://online.wsj.com/article/SB123742141942278703.html

Category: Bailouts, Credit, Derivatives, Markets, Short Selling

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

56 Responses to “Did Naked Shorting Do Lehman In?”

  1. Scott F says:

    Leverage and capitalization are important? Ratings matter ?

    Where do you get these crazy ideas from ?

  2. dead hobo says:

    So, let me get this straight.

    It’s OK to mug and strong arm anyone you want, providing they are sick , incapable of defending themselves, confusion and ambiguity can work in your favor to talk yourself out of it, you are part of a mob, you have money, and the other party isn’t as popular as you??

    Just trying to clarify a few details.

  3. globaleyes says:

    Financial Payola is the new term which defines money paid for triple-a ratings. Don’t touch that key dial.

    Thanks , Barry.

  4. dead hobo says:

    I suspect it’s especially OK to steal using the stock market when you know the cop on the beat is lazy, incompetent, and corrupt. Even if you get ‘caught’ nothing bad will happens and you might even be able to ‘sell it’ as a an example of free markets.

  5. mathman says:

    So it’s okay to sell something you don’t own, never deliver it, and not have to put up any money?
    No wonder the market works so well . . .

  6. a skeptic says:

    @dead hobo

    Whatever you think about the morality of short selling, do you honestly believe that it caused Lehman to collapse? I’d say that short selling doesn’t cause companies to go bankrupt any more than carrying an umbrella causes it to rain.

    Could you (or anyone else who shares your view) please explain how short selling caused insolvency? I thought it was due to horrific risk taking which led to massive losses.

  7. ben22 says:

    BR,

    So what do you think of people putting on new shorts at this point? I know a lot of people are watching the put/call ratio closely. I’d be interested to see if you would be willing to put up a chart or two in a few months that shows what Fusion IQ was pointing at to short around now. You did that last year with some shorts like LEH and AIG.

  8. BG says:

    This whole thing is the perfect parody of Wiley O. Coyote and the RoadRunner.

    By the time the SEC figures out what has taken place the damage has already been done and the perpetrators are long gone. We, not only have a ZIRP Interest Rate Policy, we also have a ZIRP Regulatory Policy as well.

    As a result, there are massive amounts of money being made and massive amounts lost. The SEC does not have the sophistication and computerization required to do any kind of enforcement in real time; so, traders do basically whatever they can all think up during lunch! ANYTHING and EVERYTHING that makes money is fair game. That is the only rule currently in place.

  9. ottovbvs says:

    …Is this surprise….Obviously it’s not the underlying cause of Lehman’s demise but probably the proximate one…..It rather falls into the category of speculation in taking oil to $150….Couldn’t possibly happen

  10. dead hobo says:

    a skeptic Says:
    March 19th, 2009 at 8:01 am

    … do you honestly believe that it caused Lehman to collapse? I’d say that short selling doesn’t cause companies to go bankrupt any more than carrying an umbrella causes it to rain.

    reply
    ———————–
    Using your logic and reasoning, it must be ok to prey on the weak. If you shoot a man in the head who just jumped off of a tall building but hasn’t hit, then it’s OK because he was going to die anyway in a couple of seconds? Well, if that’s ok with you, then how about putting a pillow over granny’s face because she’s old and mean and you need the money more than her?

    It’s like being a little bit pregnant. It’s impossible. You’re corrupt and stealing, or you aren’t. If you beat up an old man, injure him severely, but he dies of cancer a couple of days later, does that make it a free beating? What if he were unpopular and you were popular, does that change your answer?

    You seem to be saying that it’s OK to do bad things if you can get away with it. With a corrupt, lazy, and incompetent SEC, it is much easier to get away with it. Their nonfeasance promotes anarchy.

  11. Marcus Aurelius says:

    Naked shorting, accounting fraud, greed, short-sightedness, self interest, hubris, lack of ethics, lack of regulation, and generalized mendacious fiscal fuckery all played a part.

  12. try2bamused says:

    Nice job BR.

  13. a skeptic says:

    dead hobo:

    Just because your analogy makes sense, doesn’t mean it applies to this situation. My argument is that while short sellers profited from the company failing, they didn’t cause it to fail. You still haven’t expalined the causative link between short selling and Lehman’s balance sheet.

    Morality aside, it’s important to realise the real cause of the problem – short sellers benefited, but it was the people who ran Lehman who caused it to fail, and they’d love people to blame short sellers, as they’re a great distraction from their ineptitude

  14. ottovbvs says:

    “In the law, a proximate cause is an event sufficiently related to a legally recognizable injury to be held the cause of that injury.”

    ……..I think naked shorting of Lehman would probably meet this standard……It will be interesting to see whether the SEC under its new management want to take this anywhere.

  15. ottovbvs says:

    “Just because your analogy makes sense, doesn’t mean it applies to this situation. My argument is that while short sellers profited from the company failing, they didn’t cause it to fail.”

    @skeptic….not really true….it caused a flight of capital from the business and even worse an unwillingness to trade with it

  16. dead hobo says:

    a skeptic Says:
    March 19th, 2009 at 8:45 am

    dead hobo:

    Just because your analogy makes sense, doesn’t mean it applies to this situation. My argument is that while short sellers profited from the company failing, they didn’t cause it to fail. You still haven’t expalined the causative link between short selling and Lehman’s balance sheet.

    reply:
    ——————————-
    I never said Lehman dies from naked short selling. It died from cancer. The naked shorts just raped it a for a while before it expired.

  17. a skeptic says:

    Normal selling by longs would also meet that standard then. And you still miss the point – the share price dropping is irrelevant – the problem was that Lehman lost a lot of money, to the point of bankruptcy.

  18. Marcus Aurelius says:

    a skeptic Says:
    March 19th, 2009 at 8:54 am

    “- the problem was that Lehman lost a lot of money, to the point of bankruptcy.”
    _______

    So did everybody else. Bail-outs and the Fed/Treasury choosing who will survive and who will perish is the difference – for a while.

  19. danm says:

    Scapegoating. The public does not understand the workings of the financial system so how can we expect it to cling onto the relevant issues? No surprise here, and it’s going to get worse.

  20. gordon says:

    Rick Santelli just said “HUNDREDS OF THOUSANDS OF 10-YR TREASURY BOND ***CALLS ***WERE BOUGHT A HALF HR BEFORE THE FED ANNOUNCEMENT” … I guess I missed that one (wasn’t privy to insider info!) How is this CORRUPTION different? This is the most manipulated market in US history.

  21. ottovbvs says:

    a skeptic Says:

    March 19th, 2009 at 8:54 am

    …..Ok if you can’t tell the difference…….and see my earlier post about underlying and proximate causes….The proximate cause Lehman’s failure was: share price collapse=flight of capital=refusal to counter trade……you obviously want to believe something else so go ahead

  22. a skeptic says:

    @danm

    Exactly – everyone wants a villain, and people who made a profit are easy to go after. Partly because they have no real incentive to defend themselves (they made a profit, which is good enough for their investors), and partly because the real culprits (bankers/regulators/rating agencies/politicians) are eager to shift the blame.

  23. ottovbvs says:

    This is the most manipulated market in US history.

    ……..You must have been asleep for the past eight years

  24. a skeptic says:

    @ottovbvs

    They were bankrupt before the capital flight.

    Also, I suspect long sellers had far more impact than shorts – that was certainly the case with HBOS (according to data in the FT), though I haven’t seen the data for Lehman. If that’s the case, should we just ban selling?

    Obviously you think that the market exists for something other than valuing companies.

  25. “So did everybody else. Bail-outs and the Fed/Treasury choosing who will survive and who will perish is the difference – for a while.”–MA

    “Scapegoating. The public does not understand the workings of the financial system so how can we expect it to cling onto the relevant issues? No surprise here, and it’s going to get worse.”–danm

    too true.
    ~~
    and, when this: http://clusty.com/search?input-form=clusty-simple&v%3Asources=webplus&query=byrne+overstock+naked+shorting

    occurred/was brought to the fore, everyone was laughing at him..
    ~~

    IOW, these articles, mentioned in the post, released right before the G-20 mtg. ‘on global governance’, are mighty timely..

    “on your marks” has, as we should know, more than one meaning..

  26. Marcus Aurelius says:

    You can’t swing a dead cat without hitting a villain.

  27. dead hobo says:

    a skeptic,

    I just said:

    I never said Lehman dies from naked short selling. It died from cancer. The naked shorts just raped it a for a while before it expired.
    *****************************************************************
    I should have said:

    I never said Lehman died from naked short selling. It died from cancer. The naked shorts just raped it for a while before it expired. Then, the naked shorts cleaned themselves up, high fived each other and joked loudly about good time they just had. Then they ridiculed the victim for putting itself in a position to let it happen. They didn’t even bother to pay for the condoms or beer.The cop on the beat ignored everything and just watched. Then it went off for more donuts. The victim died alone because everyone was disgusted with recent events and nobody wanted to go near.

  28. a skeptic says:

    Lehman is no victim…

  29. ottovbvs says:

    a skeptic Says:
    March 19th, 2009 at 9:07 am

    The Bloomberg and WSJ pieces suggest otherwise…..sounds plausible to me if not to you……I’m afraid you’re using casuistry to evade the reality of what happened.

  30. ottovbvs says:

    dead hobo Says:

    March 19th, 2009 at 9:11 am

    ….A pretty good summary hobo, you just left out that some had a moral aversion to assisting victims.

  31. Myr says:

    Did naked short sales cause Lehman to fail? No. Lehman failed because of incredibly bad bets combined with ridiculous leverage. With the economy faltering, it was just a matter of time before people discovered that Lehman was irretrievably insolvent. Does a falling share price have an effect on the *timing* of the bankruptcy? Yes, but, in this case, the bankruptcy was inevitable.

    I do think there is a genuine problem with naked short sales in many other instances. There are some stocks that have naked shorts outstanding for over a year! This happens in heavily shorted stocks and it’s a crime that the SEC simply refuses to stop it. It should be a rule that anyone who fails to deliver must be bought in within 2 weeks and fined.

  32. TheInterest says:

    Here’s more information about naked shorting. Two things come from this: 1) Is there some kind of “inside baseball” thing going on here? 2) The manipulation of this Web 2.0 makes corrupting news and information so much easier.

    Presentation: http://antisocialmedia.net/lecture1/player.html

    Video: http://antisocialmedia.net/?p=165

  33. Moss says:

    The issue is that there was fraud and manipulation as the evidence on the fail to delivers points out.
    I don’t see how anyone can claim that illegal activity did not occur. We all know that it does occur on a regular basis both on the way up and on the way down. The extent of the behavior is very troubling and continues to erode the creditability of the ‘markets’.

  34. Mr Beefy says:

    Dead Hobo,

    Can U elaborate more on the rape scene? add a donkey punch for good measure! :).

  35. ItalicBold says:

    The issue here is NAKED short selling, not short selling in principle.

    HELLO, the sale of 32.8 million shares that don’t exist is nothing less than FRAUD!!!!!!!!

  36. mudpuppy says:

    There is a huge diference between shorting and naked shorting. Naked shorting is illegal but not enforced. Naked shorting is, in effect, counterfiting of stock. Naked shorting is market manipulation. To use the example of Lehman is disingenuous. Naked shorters take down many companies. It has been quite prevalent in Canada taking down junior mining companies.

  37. dead hobo:

    “Using your logic and reasoning, it must be ok to prey on the weak. If you shoot a man in the head who just jumped off of a tall building but hasn’t hit, then it’s OK because he was going to die anyway in a couple of seconds? Well, if that’s ok with you, then how about putting a pillow over granny’s face because she’s old and mean and you need the money more than her?”

    Companies aren’t people, and they don’t deserve the same compassion and mercy. In our day-to-day lives we should absolutely aid other individuals in need, and we should have a government that effectively extends these principles to individuals. But capitalism works through competitive destruction, and yes, it’s okay to prey on the weak there, even if your only reason for doing so is to make a buck.

    If anything, I’d say that accelerating the demise of Lehman is socially positive, since it forces us to take our medicine sooner instead of dragging it out a decade or so …

  38. Mannwich says:

    This increasing trend of blaming others for one’s demise is getting tiresome. So Lehman and Bear were “brought down” by outside forces and not by their own incompetence and bad management? Right. Of course, our master’s of the universe financial titans would never make any mistakes, now would they? More like they would never admit to any mistakes.

  39. usphoenix says:

    @Gordon: Thanks for the Santelli quote.

    Sounds to me like important insiders were given a tip to commit some more grand theft at others’ expense.

    This sounds like a perfect test of BO’s goal of “cleaning the corruption up”. Too bad it won’t happen.

    It would make for a much more enlightening investigation than hearings on AIG bonuses. And the traders should be awfully easy to identify. Unlike trying to unravel the CDS mess.

  40. Steven Bowles says:

    How about we forget it was Lehman for a minute and focus on the issue about short selling.

    Short selling itself is an important and positive feature of the market, nothing illegal ,nothing to see here.

    Naked short selling is illegal and can do tremendous damage to a company. Surely the interesting point in these articles is the absolute indifference of the SEC to naked short selling. They dont investigate tipoffs and they dont prosecute. This is an outrage.

    Failed trades are a very good indication something is wrong. EVERY single failed trade should be investigated. Some will be simple errors, some will be broken stock chains, some will be naked shorting. Investigate every case. Companies with repeated errors should be shut down for incompetence as they will make chain failures worse. Every case of somebody short selling without arranging to borrow the stock should be prosecuted as fraud. The SEC objective (unachievable though) should be no failed trades ever.

    The huge increases in failed trades around the rumours about lehmans look extremely suspicious.

  41. leftback says:

    @Ben22: I am fading the rally. I bought FAZ this morning. SPX 800/NAZ 1500 – time for a pause.

    “Don’t make me do it without the FAZ on…”

  42. jrnbj says:

    @Skeptic

    “Obviously you think that the market exists for something other than valuing companies.”

    Could anyone not be forgiven for thinking that the “market” as practiced by many is simply a casino?

    If it does anything, really, it measures the sentiments of a certain class of people at a given time…..

  43. ottovbvs says:

    “Naked short selling is illegal and can do tremendous damage to a company. Surely the interesting point in these articles is the absolute indifference of the SEC to naked short selling. They dont investigate tipoffs and they dont prosecute. This is an outrage.”

    ……Of course it is……you have to smile at the justifications for it as a public service from those who in the next breath will be railing against the mendacity of the Fed or bankers in general…..As I said earlier it will be interesting if the SEC under new management digs into this….or Cuomo

  44. franklin411 says:

    I love it…if I sell a bridge I don’t own, I’m a crook.

    If I sell stock I don’t own, I’m doing the world a favor!

  45. ottovbvs says:

    franklin411 Says:

    March 19th, 2009 at 12:50 pm
    I love it…if I sell a bridge I don’t own, I’m a crook.
    If I sell stock I don’t own, I’m doing the world a favor!

    …..Great metaphor franklin…..It’s a keeper

  46. uneekconstraint says:

    @jrnbj

    I agree with the “casino” mental image, but I don’t think you go far enough. The market lately seems to lack sentiment, just a herd mentality. It’s akin to throwing your money on the casino floor and walking out, or playing roulette where the game is “red or black” only.

    At least in a casino I would get a drink before I’m buggered!

  47. DL says:

    gordon @ 9:01

    “This is the most manipulated market in US history”

    I think that Hank Paulson did a better job of manipulating the markets than Geithner.

  48. DL says:

    leftback @ 11:57

    Pause, or a pullback?

  49. leftback says:

    “Pause, or a pullback?”

    Or just exhaustion, shock and awe?

    I would say pause. SPX 780 is support, SPX 800 serves as resistance for the time being.
    The 50DMA is up there above 820 somewhere, that would be the next level.
    A serious pull-back would be into the SPX 750-760 area.

    Given the Q1 “performance” issues, this rally may run another 2 weeks.
    Who knows how far this Spring Fling can roll? I am not getting in the way yet.

  50. ottnott says:

    Franklin left out some important words. I’ve added them in CAPS:

    “I love it…if I sell a bridge I don’t own WITH NO INTENTION OF BUYING IT BACK, I’m a crook.

    If I sell stock I don’t own, WITH THE OBLIGATION TO BUY IT BACK, BECAUSE I BELIEVE THAT THE STOCK IS OVERVALUED, I’m doing the world a favor!”

    Now it reflects reality.

  51. M.G. in Progress says:

    No CDS with Lehman? CDS holders may have got an interest in collapsing Lehman

  52. ottnott,

    franklin is still a student, still learning the ways of being a Master Propagandist..

    though, his teachers say he shows promise.

    f411,

    here’s a refresher:

    SELF-EVIDENT TECHNIQUE

    Appeal to Authority. Appeals to authority cite prominent figures to support a position idea, argument, or course of action.

    Assertion. Assertions are positive statements presented as fact. They imply that what is stated is self-evident and needs no further proof. Assertions may or may not be true.

    Bandwagon and Inevitable Victory. Bandwagon-and-inevitable-victory appeals attempt to persuade the target audience to take a course of action “everyone else is taking.” “Join the crowd.” This technique reinforces people’s natural desire to be on the winning side. This technique is used to convince the audience that a program is an expression of an irresistible mass movement and that it is in their interest to join. “Inevitable victory” invites those not already on the bandwagon to join those already on the road to certain victory. Those already, or partially, on the bandwagon are reassured that staying aboard is the best course of action.

    Obtain Disapproval. This technique is used to get the audience to disapprove an action or idea by suggesting the idea is popular with groups hated, feared, or held in contempt by the target audience. Thus, if a group which supports a policy is led to believe that undesirable, subversive, or contemptible people also support it, the members of the group might decide to change their position.
    http://www.constitution.org/col/propaganda_army.htm

    http://www.sourcewatch.org/index.php?title=Propaganda_techniques

  53. Pat G. says:

    Boo Hoo!! Naked short selling has been going on in the commodities market forever. Even though the CFTC has routinely “investigated” this claim. Sort of the same way the SEC did Madoff. When it is in the best interest of those with power, money or both, our markets are rigged against us. Smarten up!!

  54. a_fool says:

    Naked short selling is covered by various SEC regulations which prohibit the practice. Naked short selling can be used to manipulate the price of securities by driving their price down, and its use in this way is illegal.

    However, the real crime is Dressed long buying. Dressed long buying is the traders reciprocal of Naked short selling. Market participants who were dressed long buyers were committing the crime of supporting Dick Fuld (suitable first name) and the collective bunch of brash / arrogant tossers at Lehman Bro.

    If you were a dressed long buyer you gave Lehman the ammunition to leverage to extortionate levels. You rewarded the criminal activities of the liar loans (fabricated loans to individuals who had zero probability of paying) by supporting a corrupt management. You also funded the evenings out in strip clubs with fat ugly clients (one has to feel sorry for the strippers), fake business trips around the globe and $1,000 bottles of champaign.

    For every seller, there is a buyer – including the naked shorts. The only thing that one can conclude is that the buyers were a bunch of fools. The employees of Lehman were paid in stock so they got what they deserved.

    Lesson to be learned: Bonuses should be paid in the form of equity which only vests after 10 years.
    take note FSA, SEC, regulators.

  55. a_fool says:

    exactly AGG. Furthermore, a lot of the scumbags got new jobs in Barclays Capital (US entity) and Nomura (UK entity) so they can continue finding ways of scamming the innocent tax payer.

    Bring on the short sellers and the naked short sellers again.