Dissecting The Short Squeeze
Bank of America's (BAC) up 72% in five days. That's beyond ludicrous. So my first point is obvious: These are not normal times.
The second point is the rapidity of the move. What happened? Yes, the company reported better-than-terrible earnings, but discerning people know how they managed it: Assuming the worst was over, they lowered reserve requirements.
But even this would be met by buying in a more intelligent way. Certainly sellers would disagree with buyers, given the evidence, so any rise in the stock would be much more moderate if driven by purely fundamental forces.
But the bottom in the stock coincided with an arcane rule change by the SEC. The change seems so innocuous to a normal investor that it's beneath most people's radar. But for those borrowing the stock to short it, the rule change has been a nightmare - and it was orchestrated to be one.
Short selling's still possible, but 3 things have changed: First, there was a temporary shortage of borrowing, thus forcing a fair amount of shorts to cover. Second, the cost of borrowing has risen, such that the marginal short seller has left the market. Finally, sellers' psychology has changed: They ask, “Will the SEC make the rules even more onerous, so that I maybe shouldn’t short at all?” The objective has been accomplished: A vacuum of selling on the upside.
The situation's getting worse, not better, for credit markets and for the consumers they're lending to. The American Express (AXP) report showed that plainly: Amex was down $4 yesterday, when the rest of the financials went screaming higher. Bank of America, which has significant credit card exposure, rose 7% in an hour and a half.
So much for truth tellers.
And now the Feds are close to bailing out Fannie Mae (FNM) and Freddie Mac (FRE). At the same time, our foreign lenders (China alone owns about $400 billion in GSE debt) have undoubtedly been calling Mr. Paulson at home. Does it instill confidence in our capital markets, as Mr. Paulson gives the "raison de jour" to bailout these companies? As the list of companies bailed out grows, I would think it does the opposite.
As the price of these stocks rise, we'll start to see secondary stock offerings. The companies caught in one of the most massive short squeezes in history are in desperate need of capital. The Fed needs them to raise capital, because it's lending directly to them.
The shuffle game continues. But the game does nothing to change the reality: The system has a massive need for capital.
When buying these stocks, remember that a vacuum has been created on the downside. Short sellers produce demand for stocks as they go down. If there's no short interest (and something bad happens), this source of buying is gone.
Risk is very high.
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Great article. In previous no-bid environments, was short interest even a factor?
A couple of UK banks had very little take up on the rights recently, investors don't want to throw more money at them after what they have done up to now, why should they?
Are the Fed playing the ultimate chicken game but this time they don't know the answer because no one has done this sort of unprecedented sort or squeeze before and don't know how the market will perform when it eventually tests a low.. which it will have to because markets can't go up in a straight line
Shorts taking profits? None or very few there.
What happens if they all want to do it together?
Have the Fed engineered the ultimate Crash scenario by doing this?
I'm amazed at the number of people who simply assume this "crisis" is just a (large) bump in the road and once we've cleared the hazzard, all will be well again.
Why can so few see that fundamental changes are already taking place in our financial universe? For so long, the US (and the rest of the world for that matter) believed, and thus acted like, we were the center of the universe.
No more. Our era is coming to a close. While everyone loves the drunken bar patron while he's buying round after round, once the money (or credit in our case) runs out, he's rapidly shown the door.
As Toddo and Mr. P like to say, denial is the problem. And not just our denial but everyone who was lending money to the drunk.
Ranchers and farmers are slaughtering herds that they can't afford to feed, so the price of meat is going down - until there are no animals left and then the price of meat will then make it a true luxury.
Sitting in cash and watching the fireworks is a form of entertainment - paid for by the declining value of the $.
JPM
and if the stocks go up, its because we are picking on shorts and making it hard for them to feed their starving children.
nice to have it both ways
The Chinese led Shanghai Cooperation Organization (SCO) organized CDO buying strike last year probably caused the CDO market collapse. A SCO led buyer strike against GSE debt purchases has certainly been threatened. The Chinese want the dollar stronger. Period. They will stop buying Treasuries if they believe they must to make this happen. After all, they have been losing their shirts.
High interest rates are now baked into the pie. Maybe 10% plus bank prime rates by spring. Many of the BBB Corporates are already yielding 14%. Refinancing this debt would be very expensive in this scenario, maybe 20% plus annual rates. The more widespread effects are obvious.
