Friday, September 26, 2008

Why IBM?

In the government's glorious attempt to do the impossible, they have banned short sales of many financial stocks. Today they added a bunch more. But first, why ban short sales?

A previously permissible short sale of stock was to borrow enough money to borrow the stock at the current price, and sell the stock. The reason to do this is the belief that the stock price will decrease.

Many people claim that this is somehow unAmerican. We should only want companies to increase in value. This is like saying that we should try to prevent rain, because people do not like getting wet. Or because Hurricane Katrina was such a disaster.

This clearly ignores the problems of not enough rain, just as the ban on short sales ignores the positives of short sellers.


To eliminate the shorts eliminates the critics. Yes, there would still be the mindless talking heads with none of their own money at risk commentators. You know, like George Will telling Robert Shiller that . . . . Actually Nassim Nicholas Taleb tells it much better.

One illustration of a dangerous refusal to consider alternative histories is provided by the interview that media person George Will, a "commentator" of the extensively commenting variety, conducted with Professor Robert Shiller, a man known to the public for his best-selling book Irrational Exuberance, but known to the connoisseur for his remarkable insights about the structure of market randomness and volatility.

The interview is illustrative of the destructive aspect of the media, in catering to our heavily warped common sense and biases. I was told that George Will was very famous and extremely respected (that is, for a journalist). He might even be someone of utmost intellectual integrity; his profession, however, is merely to sound smart and intelligent to the hordes. Shiller, on the other hand, understands the ins and outs of randomness; he is trained to deal with rigorous argumentation, but does sound less smart in public because his subject matter is highly counterintuitive. Shiller had been pronouncing the stock market to be overpriced for a long time. George Will indicated to Shiller that had people listened to him in the past they would have lost money, as the market has more than doubled since he started pronouncing it overvalued. To such a journalistic and well sounding (but senseless) argument, Shiller was unable to respond expect to explain that the fact that he was wrong in one single market call should not carry undue significance. Shiller, as a scientist, did not claim being a prophet or one of the entertainers who comment on the markets on the evening news. Yogi Berra would have had a better time with his confident comment on the fat lady not having sung yet.

I could not understand what Shiller, untrained to compress his ideas into vapid sound-bites, was doing on such a TV show. Clearly, it is foolish to think that an irrational market cannot become even more irrational; Shiller's views on the rationality of the market are not invalidated by the argument that he was wrong in the past. Here I could not help seeing in the person of George Will the representative of so many nightmares in my career; my attempting to prevent someone from playing Russian roulette for $10 million and seeing journalist George Will humiliating me in public by saying that had the person listened to me it would have cost him a considerable fortune. In addition, Will's comment was not an off-the-cuff remark; he wrote an article on the matter discussing Shiller's bad "prophecy". Such tendency to make and unmake prophets based on the fate of the roulette wheel is symptomatic of our genetic inability to cope with the complex structure of randomness prevailing in the modern world. Mixing forecast and prophecy symptomatic of randomness foolishness.[1]

Some of this is more clear if you read his book, but you get an idea of just how useless commentators are in making informed decisions about risk. If nothing else - they have nothing at stake. Short sellers put their money on the line. Those who buy stocks (longs) also put their money on the line. Both have opinions, but unlike the commentators, buyers and short sellers back up their opinions with money. Making money is what investment/speculation is all about.

Why would anyone listen to some fool who doesn't put his own money on the line, but wants to tell them what to do with their money? I guess there is always a bigger fool.

When it comes to finance, everyone thinks they know what is going on. Ignoring the short sellers has been a part of the problem with market bubbles. Silencing those who actually put their money on the line - that is poor risk management.

WM was -1.526 (-90.30% from $1.690 to $0.164) just today (Friday, September 26, 2008). Almost as if the government coming in and bailing out the company is not a good thing. Those darned short sellers are the problem. This is a 6 month chart. You can see that Everything looks kind of stable. Right up until the beginning of May. Clearly, this is where the problems began. In after hours trading WM was up +1.526 (930.49% from $0.164 to $1.690) - right back to where it closed the day before

If you go back 5 years, instead of the 6 month period of the first chart, you can see that WM has had some serious problems for a much longer period of time. At least according to the one measurement that matters to investors/speculators. Price.

Some have suggested that the problem is the short sellers forcing the price down. Short sellers did not create the problem of giving money to people with no ability to pay the money back - unless the buyers were able to turn around and sell the house for more money. And the adjustable interest rates remained low enough that the buyers might be able to keep making payments. As long as everything went perfectly in their lives, and they had not borrowed more than the value of the home, and they were smart enough to sell early enough in the housing downturn to not have lost to much of the value of their ill considered rush to grab some of the money growing on trees investment. As long as they could find a bigger fool to sell to.

Back in March, GS was just under $180. I was commenting that it was odd that GS was not outperforming the rest of the similar financial companies. They were reporting record earnings. They were claiming that they were not affected by subprime. Why would the market not recognize that they were doing better than the rest? The obvious reason, to me, was that somebody knew something and was selling a lot of GS. Not all shorts will broadcast their intentions. Or it might have been someone selling a huge amount of GS they bought when they had more confidence in the company.

Remember Enron? The short sellers were telling everyone that Enron was a bad company, but people did not want to believe the evil short sellers. Enron was not the only company to feel pressure from short sellers. It is typical for the short sellers to spot problems long before any of the other analysts following the companies to notice problems.

One of the best ways to insure against bad market performance is diversification, but when the general market is going down, diversification may not accomplish much. To protect against that, people buy puts. These are options that protect against large losses. Without the ability to sell short when selling puts, the price of the puts has to go up to account for the increased risk of selling this kind of insurance.

The goal of investment/speculation is to increase the possibility of gain, while minimizing the possibility of loss. The insurance allows you to be more aggressive in buying stock, because you have protection against catastrophic loss. When that protection becomes much more expensive, the buying will decrease. This is not the goal of the ban on shorting financial stocks.

So. Back to the title of this post - Why IBM? Today there were a few companies added to the list of those which may not be shorted. Their financial circumstances are so fragile, that they need all of the market manipulation possible to keep them a break from giving up the ghost being driven down by evil short sellers.

The original 799 stocks[2] that could not be shorted was not enough, so today they added 21 stocks to the list.[3] All the unshortable companies seem to be financial - banks, credit, realty, investment, trading. So, why IBM?

The Company’s major operations include a Global Technology Services (GTS) segment, a Global Business Services (GBS) segment, a Systems and Technology segment, a Software segment and a Global Financing segment.[4]

Finally, below there are contributions from Cato@Liberty on why liberals are thrilled at this government take over of large parts of the financial markets. The hubris described by Dr. Taleb, in the passage about George Will's underestimation of the predictability of the markets, is just a hint at the damage that would be done by those on the left - those devoted to the ridiculous belief that the government can control markets. By attempting to control the markets they believe they can protect the poor pathetic common man from himself. This is far more dangerous than any private corruption could ever be.

When the Mafia sells protection from the own behavior, we recognize it as a crime. Why is this not so with the government?

One reason is that the Mafia has more control over effects of their actions than The Wizard of Oz - pulling levers behind a curtain to create the impression of potency. This is Enzyte for the financial markets. As should be obvious -

In our opinion the primary effect Enzyte had on its users was to shrink the size of their wallets.[5]

Deal or No Deal?

Fannie and Freddie


^ 1 Fooled by Randomness: The Hidden Role of Chance in the Markets and Life, 2nd Edition Amazon(US), Barnes and Noble (US), Amazon (UK). Paperback: Random House, 2005, Penguin (UK) 2007. Hardcover: New York, and London: Thomson Texere, April 2004 (1st Ed. November 2001). Published in 20+ languages. “One of the Smartest Books of all Time” (Fortune).

History has been extremely kind to the book: Of all the books published in 2001, it seems to be currently among the 2 or 3 highest selling ones, if not the highest (across all categories, fiction, nonfiction, etc.).

^ 2 SEC List: The 799 No-Short Stocks
Page 1, Page 2, Page 3, Page 4, and Page 5.

^ 3 More than 20 Firms Added to Short-Sell List

^ 4 Google Finance
IBM Summary
My italics.

^ 5 Enzyte Marketers Sued
Press Release, Hagens Berman
March 17, 2004
From Quackwatch


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