What really broke the banks

By Bill Fleckenstein

For all the finger-pointing, a thick report on Lehman shows again that incompetent management was the problem. Short-sellers merely spotted it first.

I'd like to begin by talking about short selling, something near and dear to my heart for about 12 years until I closed my short fund a year ago.  

Specifically, let me touch on the topic of all the blame heaped on short-sellers -- who trade in a way that lets them make money when a stock goes down -- for the calamity that was the financial crisis.

What prompts this week's rant: the release of a 2,200-page report on the collapse of Lehman Brothers written by bankruptcy examiner Anton Valukas and filed March 11 in a Manhattan court.

Mirror, mirror on Wall Street

It was and still is a bit pathetic to blame short-sellers, given that the table for that disaster was set by reckless risk taking on the part of the fools running large financial institutions. But all through the crisis, people such as Lehman's Dick Fuld, Morgan Stanley's (MS, news, msgs) John Mack and Citigroup's (C, news, msgs) Vikram Pandit blamed their problems on short-sellers.

(Back then, the Securities and Exchange Commission found their sob story somewhat moving: To quote from a July 2008 column on my Web site: "The SEC has announced an investigation into negative rumors that 'hit' Lehman. Funny, I don't ever remember the SEC investigating buyout rumors surrounding Lehman or Bear Stearns. . . . It would seem that they're so clueless about what the real problem is that they're stuck lashing out at short-sellers.")

I, Jim Chanos and others pointed out at the time that it wasn't the short-sellers who caused the collapse in many of the financial stocks. It was incompetent management and, most likely, one financial institution selling another financial institution's stock to try to hedge its own risk.

A lot of what occurred was also probably a function of the goings-on in the market for collateralized debt obligations -- the complicated packages of loans that got banks into so much trouble -- as sellers of these products tried to hedge out their risk.

I like many of Valukas' conclusions, including one that found Fuld "at least grossly negligent," which is something you could say about virtually all the leaders of financial institutions.

And, the report -- which corroborates what anyone with an ounce of brains already knows -- flies in the face of Pandit's testimony in front of Congress earlier this month.

Quoting the Financial Times' coverage of that testimony: "Vikram Pandit, chief executive of Citigroup, blamed short selling rather than any self-inflicted weakness for the bank's near-collapse in 2008 and thanked taxpayers for its government bail-out."

And, quoting the chief finger pointer himself: "There are ways that fear overtakes it (a specific stock), and that's the tool short-sellers need to make money."

To which I would counter: Pandit is either clueless or truth-challenged. Short-sellers do not make money by spreading rumors or pounding share prices lower. They had nothing to do with the problems of Citigroup, Bear Stearns, Lehman, Merrill Lynch or Enron.

Short-sellers simply spot trouble

What short-sellers need to make money is to find companies such as the above that are badly managed, have poor capital structures, or both, and are wildly mispriced. The facts win out in the end, and that's how short-sellers make money (after having endured managements' hype along the way).

If only it were so "easy." I would be remiss if I didn't include the force wielded by stock market speculators. I can see that speculation is starting to intensify -- with respect to the action in certain questionable stocks and the level of put/call ratios, as well as the fact that the VIX index ($VIX.X), which tracks market volatility, now sits at a relatively high 16.

All of which makes me think that sometime in the next 90 days or so there might be a decent opportunity on the short side, though that has not yet presented itself.