Posted on 03/26/2009 11:13:07 PM PDT by CutePuppy
That's the standard philosophy, but in reality, the existence of so many major market bubbles has pretty much disproved it. There is another side of this coin - since logically "smart" shortselling would (and does) tend to occur near the supposed top of the market, the short squeezes actually move the market higher and create larger and longer tops than anyone expects, with more money moving from the sidelines into the market, not the other way around. You often hear short sellers warning about the "market's irrational exuberance" years before the parabolic ascent and crash occur - that's a lot of money thrown at the market just when it's most expensive to do so and when "this time it's different" euphoria just starts to set in and people throw money at the market. In other words, The market can stay irrational longer than you can stay solvent. - John Maynard Keynes.
Bears and Bulls get mauled because short selling often extends and prolongs the market (or stock's) top, and what could have resulted in reasonable and quiet deflation of the market often results in a crash that is significantly harder and destroys more of the capital than otherwise would.
Something to think about... And, no, I am not in favor of "banning" short selling, or derivatives etc. They are just useful financial tools and can be used conservatively or aggressively, without all the damage that all too often we see they can and have been used to cause. To paraphrase, "financial instruments don't destroy capital; people, who are abusing them, do". We should see to it that they cannot. The same way we do not ban aviation or car travel, but try and take measures to prevent them from being used as guided missiles or weapons of mass destruction.
Here's a scenario:
"Megabank" had $100 billion (par value) of toxic assets.
Over time, they wrote down $5 billion on those assets and they now sit on the balance sheet at $95 bllion (marked at 95).
The FDIC holds an auction for those toxic assets.
Megabank either directly (or indirectly through a third party in order to obfuscate) bids the whole $95 billion.
The FDIC guarantees a loan for 80% of the auction price - $95 billion x 80% = approx. $75 billion.
The US Treasury puts up 1/2 of the remaining equity needed - $20 billion x 50% = $10 billion.
MegaBank puts up the remaining equity that is needed - $10 billion (they might even use TARP bailout money to fund it - wouldn't that be ironic).
Now, here's where it gets interesting. Megabank KNEW going in that the toxic assets were actually only worth 50 cents on the dollar (I'm being EXTREMELY generous with that number).
Megabank faced a write-down of an additional $45 billion on their toxic assets if they were forced to price them accurately.
Instead, Megabank now has cash instead of toxic assets, and only had to put up $10 billion in equity to get it.
Megabank fully intends to let the deal go south since everything is set up as a non-recourse loan. The MOST that they stand to lose is their equity - $10 billion. So what - that's better than the $45 billion that they were staring in the face.
Meanwhile, the US Treasury (taxpayer) also loses its equity - $10 billion.
The 80% loan goes into default and the FDIC has to cover. The original loan was $75 billion. The true price of the toxic assets is $50 billion, for a $25 billion loss (taxpayer).
Therefore, between the US Treasury and the FDIC loan guarantee, the US taxpayer ends up losing $35 billion dollars on the deal.
Megabank only loses $10 billion - and maybe even less if they take out CDS contracts on the whole deal.
When you said, "their own debt", I thought you meant bonds they issued, not bad bonds they bought from someone else.
Comparing blaming "manipulators" (notice, not "speculators", which would be trite and unfair) of the market (and providing specfic examples of how it's done) is not the same as comparing themn to "Jews" (as in Merchant of Venice and Nazi Germany and other places at other times). As a matter of fact, when the mob on Capitol Hill singled out AIG people who received "bonuses" it made me think of them being used as "Jews". And when the ACORN mob started riding a bus around those AIG employees' houses, it made me think how close are we to Kristallnacht or pogroms?
Re "short selling forced writedowns quickly rather than being papered over for 5 to 10 years," I'd much prefer the latter since it would only affect and orderly deflate the value of banks (along with their assets on the books) instead of creating a major crisis and massive destruction of capital and near destruction of capitalist financial system (which may yet happen, depending on how much "change" our new government "hopes" to inflict on us)
Good comments on OPM and most governments' (not just ours) "solutions" that extend and prolong the problems that market itself would solve (with enough temporary liquidity, necessary to quell panics).
The problem with socialism is that you eventually run out of other people's money.
To cure the British disease with socialism was like trying to cure leukaemia with leeches.
- Margaret Thatcher
DemRats equivalent of the Reichstag fire.
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